PETALING JAYA: Planning one’s finances for retirement can be a daunting and sometimes complex exercise, but one simple rule is to treat it like playing an online game.
When the game starts, the character has low-level equipment and limited coins. As the first half of the game progresses, quests are completed, rewards are earned and the character is upgraded.
But once the second half of the game begins, the objective changes. The accumulated coins must be used wisely and made to last for the rest of the game.
“We should look at retirement from a similar perspective. The first half is to build your wealth.
“The second half is to spend it but make it last,” said Employees Provident Fund (EPF) head of policy and strategy department, Balqais Yusoff, at a recent event titled Managing Finances After Retirement hosted by StarLIVE.
It is in the second half that EPF members need to get into the “decumulation” mode, referring to the idea of ensuring that their savings last for the entire game, namely, one’s lifetime.
“Accumulation is from your 20s to 50s. Decumulation starts when you are in your 60s,” she said.
Making savings last, however, does not mean refraining from spending as much as possible.
Balqais said retirees need to strike a balance between spending and saving, warning against both overspending and being too cautious to spend.
She said there are five ways members can boost their retirement savings, including starting early and consistently, deferring withdrawals, minimising withdrawals (leakages), topping up their contributions and working longer or multiple jobs.
Starting early, in particular, can make a significant difference, with those who begin saving early potentially accumulating 200% to 300% more in retirement savings.
“If you defer your withdrawals by five years, you can potentially accumulate 35% more in retirement savings, while deferring them by 10 years could result in 80% more,” Balqais said.
According to Balqais, time is the biggest “superpower” when it comes to building retirement savings, given the underpinning principle of compounding in EPF savings.
She also pointed out that many massively overestimate what an investment can do in a year, while hugely underestimating what sustained compounding could achieve over several decades.
“Do not delay starting to save for retirement. Starting early with albeit smaller contributions is more advantageous than starting later with much larger contributions.
“For instance, an individual who began contributing RM100 each month to the EPF at age 20 and continues to do so until the age of 60 would contribute RM48,000 in total and could accumulate about RM150,000, assuming a 5% compounded return.
“In contrast, an individual who contributed RM200 a month from ages 20 to 40 would also contribute RM48,000 in total, but could accumulate only about RM81,000 because the money would have a shorter period to compound. The difference here is almost twofold.
“This shows that starting early can make a significant difference, even if contributions stop later, because the money will have had more time to compound. Time is what gives compounding its exponential effect,” she said.
For those who started contributing late, Balqais said delaying withdrawals could help to partially mitigate the disadvantage.
“If retirement income can be supplemented through rental income or part-time work, delaying withdrawals by five or 10 years would allow the savings to have more time to compound,” she said.
Balqais said people are easily drawn to seemingly large investment returns, but may overlook the impact of compounding. In the context of EPF contributions, the benefits of compounding need to be viewed over a longer period, as it takes time for the compounding effect to gain momentum and for savings to double.
“If given a choice today between an investment that offers a 6% annual return compounded over 12 years and one that offers an 80% return over the same period, which would you choose? Most individuals would probably choose the latter.
“However, what many do not understand is that with a 6% compounded return, the money would double up in 12 years, giving investors a 100% return.
“This is where Rule 72 comes in – a financial rule of thumb for estimating how long it takes for money to double. At 6%, the money will double in about 12 years, while at a 12% return for example, it will double in six years’ time.
“So, while the 80% return may appear more attractive initially, the 6% compounded return eventually overtakes it. From there, the difference becomes increasingly significant as the compounding effect continues to build,” she said.
There are three approaches to setting retirement goals: income-based, expense-based and wealth-based. An income-based approach sets a retirement savings target in reference to one’s income while working. This may be based on current or pre-retirement net income, or on how much of that income one would need to replace in retirement.
An expense-based approach starts with what people are likely to spend during retirement and estimates how much they need to meet those expenses. The EPF’s Retirement Income Adequacy or RIA framework is underpinned by this approach, with retirement savings targets linked to estimated retirement expenditure.
Based on the savings accumulated by age 60, the amount is intended to be converted into monthly retirement income over 20 years, with the monthly amount increasing each year through compounding dividends.
A wealth-based approach looks at the estimated wealth a person should have accumulated by retirement, which can be benchmarked in terms of expected net worth that progressively increases with age as a multiple of annual income.
In principle, the three approaches are merely guides. Ultimately, what matters is having a clear target and regularly checking whether one is on track.
On this, Balqais encouraged members to use the EPF’s retirement calculator, which is expense-based, to track their progress towards their retirement goals and identify any potential retirement savings gaps early, enabling them to take the necessary steps to improve their retirement readiness.
Balqais said retirement adequacy ultimately depends on several factors, including an individual’s lifestyle, health and debt obligations. Rather than taking a large sum at once, retirees could structure their withdrawals over time, allowing the balance to remain invested and continue generating returns.
Beyond that, Balqais said retirees also need to consider how much to withdraw from their savings each year.
She outlined five approaches to managing retirement savings during the decumulation phase, namely, systematic or structured drawdown, preserving capital, lifetime income, a hybrid approach and age-based withdrawal.
The first is systematic or structured drawdown, where retirement savings are withdrawn according to a predetermined method, such as a fixed percentage, fixed amount or an amount that increases over time.
The second approach is preserving capital, whereby retirees withdraw only the returns generated by their savings while leaving the underlying capital intact.
The third approach is lifetime income, where annuity-based products can help to manage longevity risk by providing a regular income for as long as a retiree lives. Balqais said the EPF is looking to develop and promote annuity-based products in the medium term.
The fourth approach is a hybrid model, which combines a partial withdrawal with a regular income stream, allowing retirees to retain some flexibility while securing recurring income.
The fifth is age-based withdrawal, which recognises that spending needs may change across different stages of retirement, with drawdowns planned according to expected needs over time.
Taken together, these five approaches underline that retirement drawdown should be tailored to each individual’s circumstances and spending needs.
Retirees may adopt the approach, or a combination of approaches, that best suits them, while ensuring their savings and investments are managed according to when the money is expected to be needed.
“As a general guideline for structured drawdown, retirees may use the 4% rule to manage withdrawals while preserving the longevity of their retirement savings. Assuming the EPF gives a dividend of 5% or 6%, the returns can help preserve the capital, allowing the savings to last indefinitely.
“However, a 4% withdrawal rate may not be sufficient for some. In such cases, retirees can opt for different payout methods; whether fixed, escalating, reducing or customised u-shaped following one’s circumstances,” Balqais said.
She also encouraged members to consider i-Emas as a retirement income solution that provides regular monthly payouts, helping retirees better manage their day-to-day expenses throughout retirement.
To be sure, there is no one-size-fits-all approach to drawing down retirement savings, as the appropriate payout structure would depend on an individual’s spending needs, circumstances and how long they expect their money to last.
For instance, retirees could opt for a stable income payout throughout retirement, while others may prefer a lower payout initially that rises over time if they anticipate higher spending needs, like healthcare, in the later years of retirement.
Inflation is another factor that can erode retirement adequacy, as its impact is often less visible than the effect of compounding.
Balqais said retirees may underestimate how much more they would need to maintain the same purchasing power in the future, noting that an expense of RM2,500 today could cost more than RM6,000 in 30 years.
While Malaysia’s inflation has generally remained below 3%, she said the EPF’s returns need to consistently exceed inflation to ensure members’ savings continue to grow in real terms.
“We have always tried to outperform inflation because otherwise the value of the money will keep diluting,” she said.
Mr Money TV co-founder Peter Yong said retirement planning should also account for the possibility that savings may not be sufficient to fund a longer retirement, particularly as Malaysians live longer.
Yong said one of the biggest risks facing retirees was being lured into scams while chasing higher returns, especially when time is perceived to be running out for savings to compound.
“Retirees should be particularly wary of investments that appear to offer high returns, safety and easy access to funds at the same time.
“Investments that are safe and have high returns means the money cannot be touched for years, while safe and liquid investments means the return is low, like a fixed deposit or money market fund.”
Yong said retirement should not necessarily mark the end of earning an income, particularly as longer life expectancies mean savings may need to support individuals for several decades after leaving full-time employment.
“Today, we have moved into a world where earning an income is not just for young people.
“People with experience are becoming increasingly valuable and can continue to offer their expertise after retirement.
“Hence, retirees can consider taking on part-time roles or monetising their existing skills and experience to supplement their retirement savings,” he said.
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