Only 6% of South Africans can retire comfortably, without financial assistance. This has been a topic that has been hounding us for many years. We started Finsights with a passion to improve this terrible statistic by making people aware of financial independence and teaching the topic.

We will share our opinion on the topic and delve into the history of the SA pension industry, defining each, sharing the characteristics of each, and finally how you can create a better outcome for yourself. This statistic is an enormous problem we as South Africans face, so understanding what we can do to improve this statistic is beneficial to us and our country.

A brief history of SA pension industry

The S.A pension fund industry was started in 1956 with the Pension Fund Act. Initially, all pension funds were defined benefit pension plans. A dramatic shift took place during the 1980s and 1990s towards modern, defined contribution pension plans. There were some benefits to this change, but the biggest influence was the risk transfer from employer to employee. This risk was the investment risk, ensuring you have sufficient funds in your pension fund to fund yourself at retirement, where previously a set pension was paid to you via a formula for life under a defined benefit scheme, as some public sector (GEPF) funds still enjoy today.

Defining normal retirement and financial independence 

Normal retirement: Relying on formal employment or self-administered and self-funded pension funds with the hope of having enough to retire. This could be self-calculated or with the aid of a financial advisor.

Normal retirement has created a multi-billion Rand industry, predominantly being serviced by big life companies and their tied agents. These agents are only being remunerated for the products and services that life insurance companies can offer. The advisor industry does not advise on multiple sources of income, and hence they are not remunerated for this. It is one of the leading causes of one sided financial advice.

Financial Independence: Creating multiple sources of income during your working years with the aim of achieving your FI number as set out for yourself.

Financial independence is a concept I was only introduced to after finishing my honours degree in finance and doing a lot of extra reading in the field of finance. How was it so difficult to come by this information? Firstly, it's not being taught in schools, and not in tertiary education either. It's a mindset and a way of thinking that was gained by being naturally inquisitive. The financial independence lifestyle is all about converting your active income into income generating assets to fund your lifestyle. You should reach financial independence over the course of a few years when your income covers all of your expenses.

What is it based on and how is it calculated?

Normal retirement planning has many variables when calculated. It's no wonder only 6% of people can retire comfortably. Financial independence gives you more control over your finances, making you more mindful of your daily choices and how they will impact you. Let's delve into the differences between these two.

Normal retirement is usually based on 75% of your current income as a goal for retirement. This rule of thumb considers that you don’t have any home loans or outstanding debt when you decide to retire. A good estimation for this guideline is to multiply your current salary by 200.

Let’s start with an example: Family X, age 35, has a household after-tax income of R37 000 (R37 000 x 75% = R27 750) Their expenses per month are R32,000. Based on the normal retirement calculations, they require R37 000 x 200 = R7,4 million (as per the above guideline)

Where normal retirement is based on your current income, financial independence is calculated by focusing on your expenses. The 4% rule takes your current annual expenses and multiplies them by 25 to reach the amount of savings that you are required to live on. Based on the previous example, this family would need R32 000 x 12 = R384 000 (annual expenses) x 25 = R9,6 million.

Observation

-        Income generally follows different growth patterns for different ages. A 20–30-year-old will still be in a growth phase, where 40–50 will be mature. Calculations for age and growth in salary are unknown or guessed and can’t be considered with accuracy, making one growth assumption useless for future income expectations.

-        Your frugality is not considered at all, as the calculation only focuses on income. Do you need 75% of our income?

-        Under normal retirement, your retirement is set to a date where no future income is to be expected after formal employment ends. With financial independence, you will still be earning an income if you use multiple sources as recommended.

-        Your salary is less controllable than your expenses.

-        75% of Family X's salary is not enough to cover their expenses. Did they save enough?

-        At retirement, Family X will withdraw 4% from their financial independence fund, compared to 5.2% from their normal retirement fund, to cover their expenses, putting capital at risk and leaving less buffer room for annual income increases.

-        More capital will last longer, as can be seen in the pictures below.

Financial independence drawdown will be depleted in 46 years, while the normal retirement drawdown will be depleted in 29 years.

Sources of investment

Normal retirement only uses stock market investing via investment products from service providers. Financial independence uses three main sources of passive income, namely, stock market investing, property investing, and business investing.

Continuing with our example: If Family X invested in two properties that are paid off with minimal investment over 20 years, which generated R16 000 per month in income, they now only need R4,8 million in their stock market investment to fund their expense deficits. If they start a sideline income, then the amount will reduce even further.

Control of the process

As your investment is managed by investment professionals, you have no control over your investment outcomes during the normal retirement process. You can simply choose your risk level and trust the investment professionals to achieve these goals over your lifetime. Worse yet, you can't even negotiate their fees.

With financial independence, you have more control over outcomes. You can start a side business, invest in property, and create certainty about your monthly income. These income streams can mostly be handed over to the next generation, which makes your results an everlasting legacy.

At Finsights, we want you, the everyday hero, to take control of your finances, become aware of financial independence, grow your knowledge, and let us be your financial independence partner. 

Onward to Financial Independence