All of us at some point want to ‘die with our boots on’, but as we all know this may not happen, and we might be required to hang our boots and call it a day. This could be due to various reasons such as ill-health, lack of opportunities / stamina, inability to compete etc., It is better to plan ahead and ensure that we stay financially stable and independent in our latter years,
Retirement planning – The Need!A recent survey indicated that 80% of the working Indians do not have a retirement plan. Planning for retirement has become important since longevity has increased, while the number of working years hasn’t. Although your employer, out of concern has planned for your pension by means of the contribution towards provident fund, it would relatively be a much smaller amount when you actually get the payouts, due to the discounting factor.
The increasing rate of inflation makes it evident that things could only get dearer by the day, and it is the most important reason to plan well for the retired years. . During the earning years, investors are game for risks, and to attain about a 15% average return may seem practical but as you approach retirement age, wealth preservation strategies are replaced by wealth accumulation strategies. It is prudent to make your money work harder for you during the earning years.
What you see is not what you get!Although, today you may be spending a modest Rs. 20,000/- per month on groceries, utilities, transport and all the other mandatory aspects, the picture could change drastically over the years. Deducing an appropriate corpus should involve a detailed study of various factors - Current Household budget (excluding temporary commitments, loan liabilities), Inflation rate (till retirement and post-retirement), Rate of return on the investment, life expectancy (average Indian lives till 85 Yrs), medical contingency and so on.
Although all this analysis appears quite a task and the parameters could leave one’s head spinning, the whole thing can be understood with a simple example.
Current Age 30 Yrs
Preferred Retirement 55 Yrs
Pension as of Today Rs. 20,000 / month
Corpus Required Rs. 2 Crore
The corpus required is arrived with assumptions on life expectancy – 85 Yrs, Inflation – 6.5% and Rate of Return – 10% (post-tax). The requirement set should be realistic and hence one needs to do a reality check by visualizing what could be the plausible requirement at that point of time in future.
Investment avenuesA part of the corpus will be brought in by means of your Provident / Pension Fund (if any) and the balance can be planned by means a variety of options ranging from low-risk avenues – Fixed Deposits, Traditional Insurance plans, Income / Money Market funds, Fixed Maturity Plans etc., One can also invest partly in Equity oriented avenues – Balanced Funds, Diversified Equity Funds, Equity Linked Debentures, Unit Linked Insurance Plans, Capital Guaranteed plans etc.. However, approaching retirement years, one should limit direct exposure to equity.. It is suggested that one should not have more than 30% of exposure into equities at retirement. A rental income yield post-retirement, is a good proposition, since it provides a regular income.
The Reverse Mortgage concept is still in nascent stages in India, while it is a widely used instrument in the US, Canada and Australia, by the elderly to derive cashflows from their own house. In reverse mortgage, the retiree can pledge a property that they already own (with no existing loan on it). The bank in turn gives you a series of cash-flows for a fixed tenure.
The homeowner's obligation to repay the loan is deferred until the owner dies; bank bears the risk that the outstanding will exceed the market value of property then and will not ask for the difference from the heirs.
Few parameters are to be kept in mind while choosing the avenues for retirement planning –
• Overall post – tax returns generated by portfolio should be higher than the average inflation rate,
• Choose plans which have lower fund management charge,; given that this is a long term goal, mutual funds may turn out to be expensive than other options available around. Hence, a balanced approach would do the trick and maintaining risk profile at ‘Moderate’ levels would be vital.
• Although Annuity plans are a preferred plan amongst investors, what one often overlooks is the fact that the payouts from a pension plan will be taxed. It makes more sense to opt for a plan which works to provide for annuity but would not attract taxes during payout.
Planning for contingency and medical (both self and family) becomes vital at an older age, hence if you are above the age of 35 years, voluntarily plan for your medical contingencies (despite your existing company cover), and consider plans which will cover you lifelong.
It is important to ensure that financial independence does not elude you post retirement.
Tips of the week
- Set a realistic retirement goal – understand your risk profile, consider inflation
- Use avenues which provide post-tax returns that are higher than average inflation rate
- Look at the long term picture and build a diversified / balanced portfolio
- Do not eat into your retirement corpus before it is time
- Plan for medical, emergency contingencies
- Try to rid yourself of all the liabilities prior to retirement