New approach reframes retirement savings decision

Elze-Mari Roux

Researchers at Stellenbosch University (SU) came up with an approach that retirement planning professionals can use to offer recommendations that are simple and easy to understand for individuals who have to make difficult retirement planning decisions.

In a study published in the Journal of Financial Counseling and Planning recently, Professor Johann de Villiers and Elze-Mari Roux of SU’s department of business management proposed the sustainable lifestyle level (SLL) approach that reframes the retirement savings decision by focusing on present income and consumption rather than on future needs.

“Our approach is to ask what level of consumption (or lifestyle) an individual can afford now and still save enough to maintain this lifestyle up to and during retirement. We bring the far-off scenario of what retirement will look like, into the present – that is, what retirement income will look like in today’s terms,” explains Ms Roux.

“We suggest that the conversation between a financial planner and their client should focus on the retirement savings needed to reach the SLL. In this way, the focus of the conversation moves from the future (what shall I need in the future?) to the present (what can I afford now?).”

Ms Roux says their approach wants to help mitigate the negative effects of decisions focused more on the short-term requirement to forfeit funds than on the long-term benefit of receiving funds during retirement.

She and Professor De Villiers developed a mathematical formula to determine the proportion of income a client can consume now, while saving the remaining proportion for retirement. According to them, clients who contribute at this level should have sufficient savings at retirement to maintain their present consumption levels in retirement.

Ms Roux says that in order to advise their clients on appropriate retirement savings contributions, the retirement planning professional needs to obtain limited information from the client such as the client’s age, when they wish to retire, and the number of times their annual salary they’ve already saved for retirement. She adds that the retirement planning professional then has to estimate the real return that will be obtained on retirement savings, and the real rate at which retirement savings will be converted into retirement income.

“An example of applying this is an employee who is currently 45 years old and plans to work until 65. If this employee has accumulated three times their annual income as savings, they have to save 24% of their current income. This means the client can consume 76% of their current income and will save enough to maintain spending at this same level in retirement.

“Clients who have less accumulated savings will have to contribute more. If the same 45-year-old client has not accumulated any retirement savings they will have to save 38% of their current income and only consume 62%. Saving 38% of their income may seem like a lot to some clients, but it shows that all is not lost. A 45-year-old who has not adequately prepared for their retirement can make up for it by reducing their current consumption, and will be able to sustain this new level of consumption up to and into retirement. They will thus still be able to maintain the level of consumption that they are used to when they reach retirement.”

Ms Roux adds that clients who have saved more will need to contribute less.

She says the first approximation, as in their published paper, was not to take tax into account, adding that they are currently working on a detailed analysis of the effects of tax. “The first indication is that tax does not change the proportion of income that has to be saved for retirement. At the sustainable lifestyle level the consumption before retirement and after is by definition the same and will be taxed at similar rates.” 

Ms Roux says their main contribution is to provide an easily understandable way for retirement planning professionals to communicate the retirement savings challenge to their clients. “It requires very few inputs and the analysis can easily be automated. The answers can regularly be provided by pension funds to their members to assist them in their contribution decisions,” she says.

Dr Alec Basson is a science writer at Stellenbosch University.