Joanna Legutko
17 October 2017 | 14:45 – 15:45 | Committee 4
Relevant practice area(s):Retirement Matters
Suggested audience knowledge level: Foundational
Abstract:
Income replacement ratios are the most common way of formulating retirement targets, and monitoring individuals’ retirement readiness. These ratios can however be problematic, partly because they often do not correctly account for the impact of tax, savings rates and work related expenses, and partly because they can ignore some of the longevity and investment risks retirement fund members are exposed to.
This paper takes the position that the objective of retirement saving is to smooth consumption over the lifetime. Therefore consumption, rather than income, replacement ratios could be a more meaningful measure of whether an adequate post-retirement living standard is being targeted. Consumption can be approximated by from income by adjusting income for non-consumption items such as savings and tax. In some ways, financial planners make such an adjustment, in a very generic way, by setting income replacement ratio targets which are less than 100%.
This paper makes such adjustments more explicitly by individually calculating the consumption replacement ratios projected for a sample group of fund members, and comparing them to the reported income replacement ratios these members are expecting to achieve. The paper analyses the effect each change in the replacement ratio calculation has on the members expected retirement outcome, and comments on which measure is
more appropriate for retirement planning in South Africa.