14 April, 2016

Avoid these mistakes to ensure well funded retirement

Retirement is one milestone people look at longingly & wistfully. For most people, the reason is that they are fed-up with the humdrum routine of going to office, yes-siring the bosses, the stress which comes with today’s high pressure jobs, the toll it takes on one’s health, office politics which are disempowering & other reasons. Hence, for some, retiring early is a priority. However, that is easier said than done.
The reason – If one retires early, the survival period is longer. Hence, one needs a bigger corpus to retire with. However, since one is retiring early, they need to build that bigger corpus much earlier in life, which is a tough ask.
Retirement Planning is serious business. Retiring early is a herculean task, which requires careful planning & adjustments. Read this - http://bit.ly/1OXiLdb
The more plausible solution is to retire at the usual superannuation age of 60 & have a good enough wealth accumulation so that it may see one comfortably through the retirement years.
In this article, I’m going to discuss retirement planning options which are avoidable if one is not to end up in penury in the golden years.
Annuity option - The latest budget has put the focus on annuity ( from one portion of the EPF ). But annuity is hardly a good solution. Annuity rates are around 5.5-7%. Also, annuities are taxable as income making them a poor choice.  The same is the case with all pension plans from Insurance companies. Traditional plans can offer 5.5-7% returns.  ULIP plans can offer potentially higher returns, but the risks are borne by the policy holder. But in all cases, annuities are taxable. Also, annuities remain the same throughout life, making them less meaningful as time goes by.
Hence, if your predominant vehicle for retirement funding is through annuities, you can never hope to hold your head high ( unlike the Sar uthake jiyo pitch of pension plans ).  Annuities are at best a secondary option – not the best.
Read this piece on the flaws in annuities as they exist today -  http://bit.ly/1TYN9f6
Laddering option – Insurance agents offer laddering as a solution. They may suggest 20 endowment policies which will mature every year in retirement, ensuring that there is income coming in every year. While that looks fine on the face of it, there are problems with that. Firstly, endowment policies tend to offer 5%-7% returns. The returns are tax free. But, as you can see the returns are low.
The problem is there from the start. One would be getting into low yielding insurance products & would invest continuously for a long period. Investing in a low yielding product for the longterm would actually create a much smaller corpus at the end. For instance, if one were contributing Rs.10,000 pm for 20 years & one product yields 6.5% & another 10%, the corpus at the end of 20 years would be – Rs.49 Lakhs & Rs.76 Lakhs respectively. The difference is Rs.27 Lakhs! The corpus in the latter case would be 55% more!
Also, when one is putting money into insurance, there is no flexibility. One needs to pay consistently for a very long period, which can be a positive too. But with life being as fluid as it is today, we need flexibility to invest more or less in a year – or even skip payments, if necessary. The other problem is that all investments here are in debt products. One may be better served by a bouquet, which we will change as per the unfolding future – in which case the investment would be better aligned to one’s needs.
Even in the decumulation phase, the life insurance policy will mature, as per the policy tenure. Suppose lumpsum money is required at around retirement, that is not possible in an insurance plan. To sum it up, it is better to avoid setting up an income stream through insurance plans for they are rigid, inflexible, low yielding & without possibility of diversification & hence a concentration risk.
Relying on Fixed Income products alone -  Many make this classic mistake. They want all their money in FDs, Bonds, Small savings and the like, which are low on risk. But, these instruments will offer returns which are all subject to tax. Post tax returns hardly are able to beat inflation. In future, inflation makes things very hard if one is relies on such instruments alone. These people wrongly believe that in retirement, they should not take any risk. The biggest risk in retirement is not taking the required level of risk, so that the corpus lasts the lifetime.
Real Estate -  Many people invest in real estate so that they may fund their retirement. There are many ideas here. Some people buy land, which they would like to sell for a handsome profit later to fund significant goals, including retirement. While this is fine on the face of it, there are problems here too.
Land appreciation is overhyped. While some land parcels have appreciated very well, it is not true across the board. Also, land is prone to encroachment, as many people do not keep tabs of their land closely.  Residential & commercial property are better in that respect. But again the appreciation is not good across the board and one could get caught on the wrong foot.  For instance, in the past five years, properties in Hyderabad have given a negative return, which would come as a surprise to many. Nor is this an isolated case. Several areas across India have offered anemic returns, making property investments not such a great option.
In case of properties, one may spend on interiors, upkeep, taxes, brokerage etc. which are generally not factored in the final returns. After factoring all these, the final returns may not be all that great when the property is sold. Further, there are taxes to be paid on sale. The other intractable problem is the illiquid nature of property. One may not be able to sell property when needed, making it a difficult asset class.
If one keeps the property for rental returns, residential property can offer about 2-3 % returns on the market price and Commercial property can offer 3-6 % on market price, all of which are taxable. Hence, the yields are nothing much to speak about.
Simple financial assets may work far better in terms of returns, liquidity, predictability, taxation etc. The first thing to do is to avoid making these mistakes. In the next dispatch, we’ll see where to invest to make retirement a period of enjoyment & not one of chronic stress.
Published first in Linkedin. 
Author - Suresh Sadagopan   www.ladder7.co.in

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