Lets boil this issue of retiring down into its simplest form. We each face this one challenge: How do I build an income stream that will last from the day I retire until the day I pass into the next world?
Before I go on, lets get one thing straight. I must stress that this is my plan for retiring. I'm not suggesting that you should follow it. I have no axe to grind with anybody selling anything in this arena. I am simply trying to show the thinking process that took me down this path.
The retirement industry wants you to save a lumpsum that will be big enough at age 65 to generate that income stream (from those same firms). The biggest problems with this process, as I see them are:
- Right now I don't know what annuity rate will be used to generate that income.
- I also don't know what inflation will be.
- Nor do I know what interest rate my savings will earn.
- I don't know what new taxes and rules the government will create en route.
- All of which means that I do not know what that lumpsum should be.
There are a lot of other problems. There is no regular review of how far we are down the track. When there is a review, the numbers are often skewed in favour of the new product on offer. Imagine how much more inspired we would be if we got a monthly statement giving us all the details and projections - in English.
All of the above means that my 65th birthday is going to be one nailbiting event if I rely on numbers I cannot know until then, and over which I have no control!
It occurs to me that there is a much easier way of dealing with all the complex issues we have been discussing these past few weeks: Eliminate them from the discussion! Instead of focusing on the lumpsum why not focus on the income stream?
Lets start from scratch and assume I want an income stream of £3200 each month after retirement, growing with inflation. I look around and find that the monthly rental on a flat in Bournemouth averages £800. If I buy that flat, and keep renting it out forever (at least forever in terms of my life) I should be able to get £800 every month, and that rental grows each year more or less in line with inflation. That means that if I buy four such flats, my retirement problem is over?
Contrast that simplicity with all the numerobabbage we've had to go through to work out what that pension is really worth! (I know it is not quite as simple as all this, but please work through this with me, and then you can take the plan apart and tell me why you disagree.)
My first thoughts about this:
- The property market is in freefall, what a bad time to buy! (Of course, a couple of years ago I thought the property market was overpriced - a really bad time to buy. Bottom line - I was scared.)
- What happens if my properties end up in bad areas - like those folk who invested in Hillbrow when it was a great place? (Don’t buy them all in one place!)
- The costs of buying property are high. And the returns are not guaranteed. (In hindsight I have come to realise that NOTHING is guaranteed. But with this path I can make changes en route, which I can't do the other way. And the costs are much, much lower than any other form of retirement saving.)
- What if I mess it up? (I now realise that I will mess up at least one of the deals - hopefully that first one. But when I looked at the other route, I realised that my mistakes could never cost as much as their successes!)
My challenge is simple: How do I create an income stream of £3200 per month for the rest of my life, with just 15 years to go to retirement?
- Option 1: Traditional Route
- Assumption: Annuity Rate when I retire (for myself and wife): 4.448% (which is a wild guess)
- Assumption: Nett Savings Rate (how much I can beat inflation by): 3%
- Fact: Years to go: 15
- Which means I must save about £3794 each month, increasing by inflation each year. (Impossible, in other words.)
- Option 2: Bournemouth Flats
- Fact: Flat Price: £130,000
- Fact: Cash Needed: £23,400 (Deposit 15%: 19,500 + Costs: 3% = £3,900 )
- Fact: Bond (85%): £110,500
- Fact: Interest Rate: 6%
- Fact: Bond Payment Due: £792 (In the UK the tenant pays Council Tax, the equivalent of SA Property rates which are paid by the owner)
- Fact: Rent: £800 per month
- Which means I must save about £1000 each month, increasing by inflation each year, for two years before buying that first flat, and then repeat this process every two years until I have four flats.
- Question: Which is easier?
Rounding the numbers I need £24,000 to buy that first flat. If I save £1,000 each month, and keep increasing that in line with inflation, I can get there in two years. Given the current property market, prices are going to go down rather than up! (And if I really get impatient, after one year I can borrow the rest on all those credit cards I recommend you get as part of the CrashProof your Business strategies!)
As soon as that purchase is done, I have solved £800 of my £3,200 income stream problem! OK, so I won't see the flow in my own hands for a few years, but that flow will go on forever while the bond will only last another 10 years or so.
At this rate I will be able to buy 4 flats over the next 8 years, and have them all paid off by age 65. (I see this as a simple process, far less complex than dealing with all the uncertainties I otherwise face.) That’s as guaranteed an income of £3,200 for life as anybody could possibly offer me.
Before digging into the details, let me summarise what I now see.
- Instead of saving £3794 each month, increasing with inflation, for the next 15 years, with no guarantees that I will get the income I want...
- I can save just £1000 each month, increasing with inflation, for the next 15 years, with the best guarantee I could want - 15 years of proven income! (Actually, I could stop saving after eight years, but I want those properties fully paid off when I get to 65.)
Why choose Bournemouth? No particular reason other than I know it pretty well by now. I know that there is not much more space to build in the UK, so rentals are likely to stay high. I know that it is reasonably easy for anybody to get a bond (even South Africans) if the flat will pay for itself. I think the UK pound is likely to be more stable than the SA Rand, at least for the rest of my time on earth.
Why a 2 bedroomed flat? I like them. They’re easy to let. There is a big demand for them that should be around for as long as I live. They’re easy to find.
Why am I so confident about the numbers? RightMove gives me all the numbers I need, from property prices to rental prices, for any area in the UK.
What about tax issues? In my case I need to save so much so quickly that almost all of it will be from after-tax income. (In SA, I am allowed to save 15% of my pre-tax income because SARS know they will get the tax back when they tax my pension.) I would rather save £1000 after tax per month than £3794 (much, much, much more than 15% of my income) per month! Those initial tax benefits are lost when I look at what happens at age 65. In my plan I always own the properties, and I can leave them to my kids when I go (or when the woman of my dreams goes). (If I structure them into a Trust then there is no inheritance tax either.) In the traditional plan the funds must buy an annuity, and when both Caroline and I die there would be nothing left to leave to the kids. (I save 350% more each year to be able to leave my kids 100% less! Seems silly?)
After reading more than 1000 emails on retirement since I started this sequence, I have noticed something. Every single person writing to me who has relied on the traditional route is unhappy, and has some strong words about his/her advisors. Every single person writing to me who has relied on property (in some guise or other) to fund their retirement is happy. Seems like a trend to me.
When I started this train of thought my question was whether it is possible to save yourself into retirement. If you go to the lumpsum calculator and mess with the numbers, I think you will agree that it is very, very difficult. My calculations show that an 18 year old in the UK will have to save £697 each month, increasing with inflation each year, to have an income of £3200 from 65 onwards. (Starting income for an 18 year old in the UK is about £1200!) In SA, for this same 18 year old to have an pension of R20,000 per month would mean a monthly saving of R4356 each month, increasing with inflation each year! (Don’t know about you, but sure seems unlikely!)
And finally, I have based all my numbers on the UK because it is easy for you to check out the same resources I used, and after living here for two years I know the numbers here better than in SA. The principles remain the same, but the exact numbers may be different. Since one of the most common questions that has been raised in the emails I have received is the uncertainty about the future in SA, why not consider investing in the UK instead?
I am going to stop right now, and ask you a question. If you want me to continue with this series, adding the spreadsheets and calculations I used for the property purchases, I would be happy. Just tell me you want it, or tell me why it won’t work for you, or ask me a question here. (After three intense weeks on the subject I am suffering battle fatigue.)
Peter Carruthers
August 13th, 2008