There are plenty of reasons why people fail to save enough for retirement, such as inertia, lack of cash, or more immediate spending priorities.
Ignorance is another problem: too many underestimate how much they need to set aside, and how little income that will generate in retirement.
After reading this article, that should no longer be an excuse.
Why you must start saving today
There is one golden rule of pension saving: the earlier you start, the better.
Stuart Ritchie, a chartered financial planner at UAE-based advisers AES International, says too many expats leave it too late. “The first dollar you save will always be the most valuable, because it has so much longer to grow in value.”
This simple calculation shows why. Say you start saving US$500 a month at age 25. By age 65, 40 years later, your total pension pot will be worth $592,959, assuming annual growth of 5 per cent, minus 1 per cent annual charges.
However, if you do not start until age 45, and invest $500 a month for just 20 years, your pot will be worth just $185,815.
Although you have paid in half the amount, your pension isn’t half the size – it is just one third of the size.
Mr Ritchie says you need to give compound interest as long as possible to work its magic: “Delaying just a few years can make a massive difference to how much you ultimately save.”
Playing catch-up isn’t easy. Even if you invest $1,000 a month from age 45 your pot will total just $371,630. That is roughly $220,000 less than if you invested $500 monthly from age 25, even though you have paid in exactly the same.
How to hit that target
So how much do you need to save to enjoy a comfortable retirement? A pension pot of $1 million sounds like a good benchmark target, although it may still not be enough. So how much should you save to hit that?
At age 30, you would need to save $1,091 a month to build a cool million by age 65, according to figures from AES International. Delay until age 40 and you need to save almost twice as much, $1,939 a month.
From age 50 you need to save twice as much again, or $4,050 a month, while at 60, the task becomes a near-impossible $15,033 every single month.
All these figures assume exactly the same annual growth rate of 5 per cent a year, minus 1 per cent charges.
Mr Ritchie says, “If your investment plan charges, say, 2 or 3 per cent a year, this will reduce your growth rates sharply, forcing you to save even more.”
He says you should avoid most structured offshore savings plans, which have hefty charges, and look for low-cost alternatives such as exchange traded funds (ETFs) which charge as little as 0.5 per cent a year, plus your advisor’s fees if you have one.
What does a million dollars buy?
So how much income does $1m buy in retirement? Far less than you think, is the sobering answer.
Tom Anderson, a private client investment manager at Killik & Co, says somebody who left a million in cash earning 1 per cent a year would currently generate paltry annual income of just $10,000.
“You could get more from investing in government bonds, but they pay little more than 2 or 3 per cent, giving you around $25,000 a year.”
That is scant reward for a lifetime of saving, and would force many to repeatedly raid their capital, eroding their future income stream.
Mr Anderson says you can invest to generate income of around 4 to 5 per cent a year by investing in dividend-paying stocks or mutual funds. “You take around $45,000 a year without touching your capital. The problem is that stocks and shares are volatile, and a stock market correction could hit the value of your pot.”
Things can only get better
You should also remember that inflation steadily erodes the value of your savings, so $1m will not buy as much in future, and rising life expectancy means it would have to last 30 years or more.
Today’s low interest rate world makes generating income from your pension harder than ever before.
There are encouraging signs that rates may start to rise, with the US Federal Reserve hiking in December and it plans another three increases in 2017.
One thing will not change: you still need to save as much as you can, as early as you can, to get the retirement you feel you deserve.
pf@thenational.ae
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