Income Replacement Formula : The foolproof method to build your retirement fund

In one of my posts, I delved into income replacement; its definition, benefits, and application in your financial journey. Now let’s look at the income replacement formula. You need to replace your income immediately you retire.

Application of the formula

If you want to earn a specific sum of money per month in your retirement, you need to save 120 times that sum.

Suppose you want to earn Shs 5 million monthly, you’d need to have saved Shs 600 million by the day you leave employment.

You’d place your cash into an investment vehicle like a unit trust, for a 10% average rate of return annually. That would translate to Shs 60 million per year and Shs 5 million per month in interest. You’d live off that Shs 5 million interest.

How to save and come up with the funds

It’s feasible build such a fund, with the right financial tools ,discipline and time.

To save successfully, consider the following factors, which will affect your saving plan:

• Income sources

These include salary, provident funds, social security funds, and business income. It also includes proceeds from liquidated assets like land or a business.

• Your current age

A 25-year-old person has more time than a 50-year-old, to save and will therefore accumulate more funds. This doesn't mean the latter should not save; it just implies that the amount required for savings, would be significantly higher than the former due to the limited time available toward retirement.

• Risk tolerance

This is the propensity to take risk. A young person could easily recover from a failed business. Time is his ally. At 50 years, starting a business with an all-or-nothing mentality is high-risk. The business might fail.

At 50 years, starting a business with an all-or-nothing mentality is high-risk. The business might fail.

• Liquidity

This is crucial during retirement. It’s how fast you can turn an asset into cash. It is better to transition your assets to cash, as you head towards retirement. In old age, cash is king, not square miles of land.

Fund-building tools

1. Unit Trust : Is an investment vehicle that allows you to earn compound interest and grow your money over a long time. It works best when funds are saved over a long time (more than 10 years) and not withdrawn.
2. Life Insurance : This is a protection tool, which provides a payout incase you lose your source of income (salary or business) due to incapacitation or ill health. It is designed to shield you from financial hardships. The payout from a life insurance policy could also be transferred to a unit trust if the policy is an endowment policy.
3. Business : Use some of your business proceeds to create a cash fund in a unit trust. Business owners, that are unable to run the business could sell the business and invest the proceeds into a unit trust or a bond.

Creating an income replacement fund, is a long term endeavour.

The income replacement formula is a practical tool you can use for your financial planning. It will provide a simple, straightforward approach to determining exactly what resources you need to build your fund.

The income replacement is a risk mitigation tool (against the risk of loss of income).

Income replacement is a risk mitigation tool (against the risk of loss of income). Apart from retirement planning, it could also help you put in place safeguards just in case you lose a job or become too ill or incapacitated to return to work. Inability to return to work would mean the loss of income.

This is why you need to plan appropriately from the beginning. You need the services of a financial planner. A financial planner is a guide for your financial journey. He or she will design the right plan for you and recommend the best tools for you, according to your needs.