MOST PEOPLE UNDERESTIMATE the money they need to save in order to fund their retirement. Similarly, they undervalue the pension arrangements made by their employer and the National Insurance Scheme.
Consider that you, retiring at 65 years old, are offered a retirement package. It would be your only financial support during retirement.
There is an element of choice, however: you can either choose to have a lump sum in cash of $1 million, or you can choose to have a monthly amount of $5 000 for life and for a minimum of 20 years if you should die before then. Which would you choose? Which of these options has the most value to you?
The choice you make has been shown by research to indicate how you see wealth and how you see poverty. Your choice is a leading indicator of how you handle money.
The alternatives are really equivalent based on normal annuity projections at age 65. If your choice was the $1 million in cash, you are leaning toward an illusion of wealth where the large sum of money makes you feel that you have more. On the other hand, if your choice was the monthly sum, you are leaning towards an illusion of poverty and would think that the monthly sum will consistently meet your expenses.
This example also draws attention to the need to display the funds accumulated to date on pension statements or in annuity plans as an estimated monthly payment on retirement. For making such an estimate, a rough number that can be used as a divisor is 200.
That is: the lump sum/200 gives the approximate monthly payment. So, for the $1 million lump sum, the equivalent monthly payment is $1 million/200 which is the $5 000. Alternately, for a monthly payment of say, $2 000, you will need to have saved a lump sum of $2 000 x 200 which is $400 000.
You are therefore in a position to calculate the alternate lump sum value of the National Insurance pension to which you are entitled. Say that you are entitled to a monthly sum of $2 300. Then that is valued at roughly a lump sum of $460 000. The major difference, though, is that such pension is only payable for life, which may be more or less than 20 years past 65 years old.
People who have the illusion of wealth would tend to overspend and may eventually find themselves in financial difficulty. People who have the illusion of poverty tend to underspend, scrimping and saving further.
They do not value large monetary sums of money commensurately. They will tend to forego such discretionary expenses like entertainment and pricey overseas trips, which they can ably afford, in order to save further.
With a better idea of the sum you may need to maintain your lifestyle during retirement, you can now plan to save accordingly. You can also see the merit of starting to save towards building up a suitable lump sum from as early as possible. It is also desirable to be going into retirement with all significant debt, particularly mortgage debt, fully repaid, thus reducing the pressure on the monthly sum needed in retirement.
By definition, pensioners are wealthy when they have saved commensurately with funding the retirement they desire. True wealth is not necessarily a large lump sum of money or a significant cache of valuable assets, but being able to generate the cash flow necessary to maintain the lifestyle to which you have become accustomed without having to work anymore.
• Louise Fairsave is a personal financial management adviser, providing practical advice on money and estate matters. Her advice is general in nature; readers should seek advice about their specific circumstances. Email: Louisefairsave@nationnews.com . This column is sponsored by the Barbados Workers’ Union Co-op Credit Union Ltd.