The salary replacement ratio

Most of us save for retirement in some form or another. All of us, however, hope that when we retire enough investments have accumulated for a dignified retirement. Instead of just hoping for the best, one should plan for retirement and one of the tools that can be utilized is the salary replacement ratio.  This ratio expresses the pension that will be received on retirement as a percentage of the pensionable salary in the last month before retirement. The table below reflects this ratio, based on certain assumptions.

The table is read as follows: a member that has invested in a portfolio (or combination of portfolios) that yields 4% above inflation and who has contributed 14% of pensionable salary to a retirement fund will have a replacement ratio of 63%. The pension to be received will be 63% of the last pensionable salary. It is important to note that contributions listed above are after risk premiums and other costs, i.e. it is the actual portion that is set aside for retirement. Total contributions to a retirement fund for this member could be something like 17%, where perhaps 3% is used to pay for death and disability cover as well as administration and other costs.

Another important assumption underlying the above ratios is the number of years that the member contributes to the retirement fund. In this case we have assumed 30 years of contributions until retirement age 60. Life expectancy after retirement has been assumed as 20 years. Where a member changes jobs, it has been assumed that any accumulated fund credit is preserved in a preservation fund and not eroded in the form of a cash withdrawal.
Four factors are crucial to ensure a dignified retirement:

• Net contributions and investment returns need to be balanced. Where a moderate risk portfolio is chosen that yields on average 4% above inflation (after fees), net contribution rates should not be lower than 13%. Use the table to establish where you lie. Make changes while you still can.
• Pensionable salary should not be significantly lower than total remuneration package. Your standard of living is largely a function of your total remuneration. It is the pensionable salary however that determines the pension you will be earning one day.
• Setting retirement savings aside is a long process. The longer the period you save for retirement, the better. As a minimum it needs to be 30 years.
• Do not access your retirement funds when changing jobs, no matter how tempting it may be.

Important notice and disclaimer
This article summarises the understanding, observation and notes of the author and lays no claim on accuracy, correctness or completeness. Retirement Fund Solutions Namibia (Pty) Ltd does not accept any liability for the content of this contribution and no decision should be taken on the basis of the information contained herein before having confirmed the detail with the relevant party. Any views expressed herein are those of the author and not necessarily those of Retirement Fund Solutions.