Delaying your retirement

Longevity has become a major concern for governments and individuals around the world as it poses a challenge not simply because people are living longer, but also because labour and economic trends have changed significantly over the past decades. Very few employees spend their whole working career with a single employer as many nowadays will have more than one career over their working lifetime. From a retirement savings perspective this makes it difficult to find a simple solution to the ‘problem’ of longevity.

Traditionally defined benefit schemes didn’t carry longevity risk

Under the old defined benefit (DB) retirement schemes, pension savings were part of an employee’s incentive scheme. It was structured to benefit those whose who remained in service the longest and penalised employees who wanted to leave for other employment. As retirement savings were on balance sheets, i.e. belonged to the company and the company carried all the shortfall risks, it provided a long-term incentive (and responsibility) for management and employees to ensure that the company was around to pay their pensions. Under DB schemes therefore individuals didn’t have to plan for their retirement if they had a long service and the only major risk to their pensions was the bankruptcy of the employer since pensions were paid until death.

Over time, however, as the mobility in labour markets increased and people started changing jobs more frequently, DB schemes became increasingly less viable for employers. Firstly, employees wanting to change jobs demanded that they receive their full pension savings meaning that retirement schemes were no longer the best retention strategy.  Secondly, disputes arose around the surpluses in DB schemes, resulting in employers not being able to build up surpluses in good times to cover periods of poor market performance where risk of a shortfall was high.

Under defined contribution schemes the individual carries longevity risks

Most employers have therefore adopted defined contribution (DC) retirement schemes where the retirement savings is held in a fund on behalf of the employee. There is however a fundamental difference, DB schemes were incentive schemes whereas DC schemes are just another form of savings for which the employee is ultimately responsible. Longevity was never an issue under DB Schemes but is a major problem under DC Schemes as it is now the employee’s responsibility to save up enough to cover an uncertain period of retirement. As life expectancies in the developed world have steadily increased, outliving retirement savings have become a real challenge facing retirees.

It is clear that in the new world, it is vital that individuals take ownership of their total financial well-being, ideally by always having a bird’s eye view of all their savings. Culturally, the continuous rise of individualism will make it difficult to establish a one size fits all solution. The best that regulators and employers can possibly do is to facilitate an environment which empowers individuals to know how much they need to save and understand the potential risks they face if they don’t save enough.

This will off course help those who have just started their careers, but what about employees who are only five or 10 years away from retirement? Many of these prospective retirees would have started their careers under a DB scheme but have since been migrated over to DC schemes. How do they cope with current retirement age policies which are set at between 60 and 65 in South Africa given that they may well live to the ripe old age of 90 and beyond?

Facing longevity risk

For those nearing the traditional retirement age, it is important to acknowledge that longevity is a real risk. There is clear evidence that people nearing retirement underestimate how long they will live. The graphs below illustrate this by showing the results of surveys conducted by asking people of different ages how long they expect to live and compares those to mortality tables. Women as a whole seem to be more pessimistic than men, but for both sexes there is a clear trend. Prior to the traditional retirement age both sexes underestimate their longevity risks. It is interesting to note that there is a point where individuals start overestimating how old they will get, but for both sexes this is well beyond retirement.

Given that corporate retirement ages in South Africa are between 60 and 65, it is becoming increasingly important for individuals to put actionable plans in place to extend their working careers. Globally, retirement ages have been increasing and are approaching the age of 70. This means that South Africans may need to plan for between five and 10 years of additional employment to match global developed countries’ retirement ages.  This may entail:

• engaging employers on increasing their retirement age or discuss possible contract work after official corporate retirement, or
• considering a post-corporate retirement career in a company that doesn’t have stringent retirement age policies.

Benefiting from compounding by delaying retirement

Delaying retirement can reduce the risk that longevity poses and dramatically increase the probability of retiring comfortably[1]. Working for longer allows your retirement nest egg to benefit from compounding since you are not drawing down on your capital. The table below provides an example of someone whose corporate retirement age is 60 and is delaying retirement by five and 10 years respectively.

We have assumed the following: 

• No additional contributions are made to the retirement nest egg after age 60.
• Prior to the actual retirement, savings grow at inflation + 4% after all costs.
• During retirement we assume the same growth but take market volatility into account as it can have a material impact when drawing from your capital.
• Required annual withdrawals increase at inflation.

From these conservative estimates one can clearly see that delaying retirement mitigates longevity-risk significantly. An individual retiring at 60 will in all likelihood run out of money between the ages of 69 and 76, whereas someone delaying retirement to age 70 will only run out of money between ages 84 and 96.    One can also see that delaying retirement can increase the standard of living for a retiree as the annual withdrawal rate as a percentage of total retirement capital decreases from 10% to 6.9%. This means that a retiree that withdraws a lower percentage from their total savings pool can deal more easily with unforeseen events such as medical expenses not covered by a medical aid.

Overall, delaying retirement by a few years will dramatically increase your chances of retiring comfortably while also allowing your retirement capital to grow. This, in turn, will reduce the chances of you running out of savings. 

[1] See ‘Can you afford to retire at 65?’, Q2 2014 Quarterly newsletter