30 January, 2014

How to plan your retirement funding

Retirement Planning
All of us have seen brochures for pension plans showing old couples laughing and playing in the park with their grand children; or an old couple walking in the beach, hand in hand; or enjoying with their friends at a party.  Pension plans are sold that way. Most people have the morbid fear of having not enough money in old age and depend on their children for money. Today, no one wants to be in that situation.

That is why “Sar uthake jio” was such a hit campaign.  It talked to the innate desire in every one of us to be independent, self-reliant and respected. But, unlike what the advt. was trying to sell, there are several ways of accumulating a retirement corpus, than just going for random pension plans.

Understanding the importance of retirement funding :  Most people do not give retirement the importance it deserves.   Infact, this does not figure as a priority item at all in a lot of cases till they are in mid forties.

Today, the retirement corpus required would be quite huge. Inflation in the past four years have been alarming. The latest Consumer Price Inflation (CPI) figure for Nov 2013 is above 11%. We need to bear the effect of inflation in mind as this an ever pervasive demon which undermines one’s spending power. If one wants to maintain the same standard of living in future.

The figures are daunting.  Assuming that a person is spending just Rs.20,000 pm now, his expenses at the time of retirement in about 20 years would be Rs.77,300+ pm, assuming 7% inflation throughout.  Normally expenses come down in retirement.  Assuming a 25% reduction in expenses in retirement, the expenses would still beRs.58,000+ pm, in the first month after retirement. 

Assuming that 7% inflation prevails throughout and he is able to generate a real return of 1% above inflation in the retirement phase, the corpus requirement assuming a survival period of 25 years in retirement, is Rs.1.5 Crores. Mind you, this corpus will be entirely used up in these 25 years, with nothing left. For other tenures & expense levels, please refer to the table.

This shows the amounts involved are fairly large and one needs to save for it, for a longtime. If not, the amounts to be saved at the end would be rather huge. For instance, for  Rs.2.5 Crores corpus, one needs to save in excess of Rs.60,000pm, if one has just a 15 year period. If one has 30 years to do the same, the amount to be saved per month becomes a far more manageable Rs.11,000 per month! Hence, starting to save early for retirement is imperative, if one wants to pace it properly and not be overwhelmed in the later years.

Basic principles to keep in mind :  Firstly, we need to understand that  retirement funding is a very important goal, which cannot be compromised.  Since retirement is a long way off in most cases, the seriousness of disciplined funding for retirement is not realized in lot of cases.  Normally, retirement funding is subservient to various goals like children’s education, marriage, vacation and the like.  This is completely wrong. Secondly, some of the goals can be funded with loans. For instance, education can be funded with loans, which can be paid back by the student himself/ herself instead of using a part of the retirement kitty for that. Retirement on the other hand cannot be funded by any other means. Thirdly, regular funding for retirement starts much later in life, say when a person is in his/her forties. As seen earlier, the longer the tenure of  contribution, the lower the amount required. For instance, if a person is going to contribute to the retirement corpus for 35 years for a target amount of Rs.2.5 Crores, s/he needs to contribute just Rs.6,500/-pm!

Strategy for saving for retirement  :  For someone in their twenties and early thirties, they should contribute aggressively into equity / equity funds as these assets have good potential for long-term returns. For instance, people in this age group can have as high as 75% in equity assets. Apart from this, they could invest in PPF. If they are employed and there is a EPF contribution, so much the better. Only that, they should not withdraw it and use it up when they move jobs. They should instead transfer the kitty into the new account.  

The other good investment option for them would be National Pension Scheme. For those between 35-50 years of age, their equity assets should be anywhere between 55-70%, depending on the years to retirement. They could also contribute in PPF, NPS & long-term Debt funds.  Those above 50 years are nearing retirement. Their asset allocation should be rebalanced to between 40-50% in equity assets. They should now have substantial amount of assets in debt instruments of all types. They should have a good PPF kitty, EPF in case they are employed,  FDs, debts funds, NCDs etc.

Strategy for income in retirement :  Nearer retirement, their kitty should be about 40% in equity. Also nearer retirement, one should set up avenues to get regular monthly, quarterly, half yearly cash-flows. Depending on whether one is coming into the tax slab or not, the investments need to be structured. For instance, Senior Citizens Savings Scheme (SCSS) would be a good instrument for someone who is not going to pay tax. For someone in the 30% tax bracket, getting 6% plus after tax, is not very exciting. 

Debt funds could be another instrument that could work very well for those in the higher tax brackets. One could invest in the growth mode and set up systematic withdrawal plan for the amount required, looking at the sustainability, based on the corpus size and the returns the debt fund is giving. This could be a wise strategy as the effective tax on debt funds could amount to just 5-6%, due to capital gains tax treatment, after a year. Depending on the tax slab one is in, one could also look at the desirability of setting up an immediate annuity for a part of the corpus. This will ensure sustained income, though that income is taxable as on date. This is however expected to change in future.  Tax-free bonds also offer annual income on a sustained basis, for 10-20 years and could be a good income planning tool.

In conclusion, retirement is a goal which needs to be addressed on priority.  It is important that everyone takes this seriously and start saving up for their comfortable retirement.  

Article published in December 2013 in Business Standard;
Author : Suresh Sadagopan;

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