16 April, 2016

Approach to take for a well funded retirement

This is the second instalment on Retirement. This piece talks about what you need to do for a well funded Retirement.
At every point in life, we are seized with what appears to be supremely important preoccupations to us.  During the twenties, the gadgets take centre stage. Living it up, partying & a bit of travel would seem like primetime activity, with quite a bit of money sapped in these. In the thirties, marriage, house, vehicle, white goods  etc., come under focus & suck up available cash. In the forties, children’s education, vacations & home loans would be some of the major expenses.
Most people have not thought about a thing called retirement till this point. Retirement seems far – beyond the horizon. And thinking about retirement, makes one feel old, almost ancient.
But, we all need to think about it – sooner, than later.  The sooner we think, lesser the money that needs to be saved per annum, till retirement.  That amount can be mind-numbingly large, if you start late.
An illustration - For instance, if one starts putting aside about Rs.4000 from age 25, till retirement at 60, the amount at retirement ( @10% returns ) would be Rs.1.5 Crore. To reach the same figure if one starts at 45 years, the saving per month would have to be Rs.36,200 – or over 9 times !
Let’s look at it another way – If one saves Rs.4,000 from age 35, one would reach Rs.52 Lakhs – one-third of what it would be had one started at 25!  That’s the power of compounding at work for you.  Rabbits can never hope to beat the tortoises that have started early – a signal lesson from Panchatantra!  Starting early is the first lesson.  Just because Retirement is Beyond Visual Range, it cannot be ignored.
Lock them up & forget them -  Choosing good instruments to invest in is important. Choosing those which are also difficult to dip into is even better – atleast from retirement planning standpoint.  Instruments like EPF, PPF & NPS come to mind.  All the three are notoriously difficult to access money from. One can dip into it ofcourse, under certain conditions; but it is not easy to just redeem them out like in the case of a FD or Mutual fund schemes. This inbuilt rigidity is a plus as it stays out of bounds!
Contribute well into these funds & forget that you have invested there. Even if you meet the conditions to draw out some money, resist it.  It’s money for your Golden years. You cannot take a loan for that. You may not be able to go back to work then – you may not get one & health may not permit. You need to do this for yourself.  Don’t dip into this cookie jar.
Take risks early on, think longterm -  Start off with equities/ equity oriented funds early in life.  They may be volatile. But they perform over time.  Start a monthly investment in a couple of good Equity Mutual Funds for the longterm. Review their performance, say once a year. Change only if absolutely necessary – if they have become laggards; or if you need to switch to another category, say Multicap funds ( from Largecap funds ). The allocation in equity & within equity is based on Risk tolerance levels of a person. Get that allocation right. Seek professional help, if necessary.
Equities have delivered over the longterm – Sensex has given 17%+ returns, over 35 years.  There have been periods when the returns from the stockmarket have been low – for 3, 5, 7 even 10 years. That’s precisely why you need to give it time. Investing early & staying invested for long periods really helps.
The much vaunted property investments work just for that reason. Just because price discovery is difficult, it is illiquid, there are taxation issues etc., people keep it for a longtime – and then they gloat that they have got great returns from property. Equities, if held for such long periods as properties, would beat the daylights out of them, 8 times out of 10.
Thinking beyond FDs -  For a lot of people, FD is the weapon of choice for all situations. For shortterm, they will invest there; for children’s education they will invest there; for retirement too, they will invest there.  The problem with FDs is that the interest rates are modest, made far more modest as it goes through a shredder called income taxes. Most FDs are offering just 7.5% pa now. A person in the 30% tax bracket would just end up with 5.18%.  That would not beat inflation.
Fixed Maturity Plans  - We need to somehow circumvent the shredder & limit that haircut, as much as possible.  Fixed Maturity Plans ( FMPs)  [these are debt mutual funds schemes with a tenure ] with three years or more maturity period, will be eligible for indexation benefits & long-term capital gains tax treatment.  In simple terms, suppose a FMP is offering 8% return, even post tax, it will be very near that figure! Also, in case of FMPs, they invest in instruments whose maturity coincides with the maturity period of the scheme and hence one is insulated from interest rate fluctuations that may happen in the next three years.
Debt funds & setting up SWPs -  Other Debt funds also enjoy the indexation & capital gains tax treatment after three years. Hence, it would be great to invest in them too. Debt funds are open ended & can be liquidated, if there is an urgency. Some of us are not comfortable with debt funds because the returns are not fixed. The reason is that there are many underlying debt investments, which are all traded and hence NAV can fluctuate. But, they will largely mirror the interest rate in the system. The advantage here is the beneficial taxation ( beyond three years ).
We can setup Systematic withdrawals from Debt funds in retirement. Systematic Withdrawals Plans ( SWP ) is drawing down a specific amount on a regular basis ( say monthly ), for a period of your choice. This is like setting up an annuity as per your convenience & drawdown requirements.  If we setup a withdrawal which would be less than the annual interest, it can be sustained in perpetuity! 
They are again super tax-efficient as withdrawals are treated as redemptions. One needs to pay taxes on the difference between the purchase price and sale price of the units – hence it is very low – as low as 2-3% effective tax!  SWP  is hence a very useful & effective retirement income setup tool
Tax-free Bonds -  The other tool of choice is a tax-free bond. Tax-free bonds were available for subscription this year ( and in some previous years ). This was available in some previous years too. This year it has offered between 7.2% – 7.65% pa returns. The good part is that there is no tax to be paid on this.
It will offer regular income for between a 10-20 year period, which is a major plus. Hence, with this instrument, one is insulated from the interest rate fluctuations & can hope to get consistent income for a long period. This is especially useful to take when one is nearing retirement or is retiring.
Immediate Annuity – One may consider purchasing a pension option ( called immediate annuity ) with a portion of the retirement corpus. This will offer sustained income. But the annuity is entirely taxable as income. So, if one is in the lower tax brackets or not in the tax bracket, this will work.
We have discussed the instruments one could invest in the runup to retirement as well as  near retirement.  One can use a combination of these instruments to come up with a bouquet that will suit them the most.
Just remember to rein in the excesses of the youth ( moneywise! ).  Remember that Retirement is somewhere beyond the horizon. You will get there one day. You can choose to be prepared for a fully funded retirement. 
Now, start counting the beans you can put aside for retirement!
Authored by Suresh Sadagopan |   published first in Linkedin |

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