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Although many financial planners suggest that households should plan to retire on 75 percent of their income at retirement, new research suggests an entirely different approach.

Megan Butler, Research Actuary at Alexander Forbes and lecturer at the University of the Witwatersrand, considered the income and expenditure profiles of almost 3000 households and found that contrary to popular belief South African households do not reduce consumption voluntarily on retirement. In fact, for certain households, consumption increased in retirement due to higher health expenditure. The lower expenditure of retired households that is seen in practice may well be a result of pensioners having lower incomes than what they had while working. These pensioners are thus forced to reduce spending.

"If not limited by their lower incomes, these households would spend at similar levels to what they did while working," argues Butler.

Butler’s research, conducted as part of her Master of Science at the University of the Witwatersrand in Johannesburg, considered the lump sum that would need to be accumulated at retirement in order to avoid households being forced to reduce consumption at retirement. The results suggested that households need more than previously thought and that retirement needs differed dramatically between different types of households.

In South Africa retirement adequacy is typically measured by a replacement ratio which gives the income in the year after retirement as a percentage of the income in the year before retirement. Many calculations are performed using pre-tax incomes and most funds use targets of between 70 percent and 79 percent. However, a gross of tax replacement ratio target of 79 percent was inadequate for at least 82 percent of single females and at least 88 percent of single males.

If couples were considered the results were better, "particularly if the younger partner continued working after the older partner retired. That said, only about half of couples would find a target of 79 percent enough to avoid a consumption drop at retirement," added Butler.

Although the development of a complete set of retirement benefit targets for South African households requires further investigation, the results have important implications for individuals, retirement funds and financial planners.

Article continues on page two: how to improve your position in retirement...