Five steps to retirement planning

Besides inflation, longer life-spans could worsen retirement woes, as increasing life expectancy may require us to fund a longer retired life.

Suresh Parthasarathy, Business Line, 1/5/2011

Planning for retirement often figures last in the priorities for an investor. Most of us plan for children’s education, their marriage, home-buying and even holidaying, much ahead of setting aside money towards retirement.

Yet, if we start early in planning for retirement, the magic of compounding greatly simplifies our task of addressing longevity and inflation. If you wish to make your retired life more comfortable, read on.

Why Retirement Planning?

Raghav, who works as a chief manager at a chemical company, says he constantly regrets two things — not accumulating enough of a retirement corpus and not properly preserving whatever little he saved for retirement.

Shekar, who retired from a sugar company, received Rs 20 lakh as retirement benefits, but recently suffered setbacks to his health which required a coronary bypass surgery. His medical expenses of Rs 9 lakh made a huge dent in his retirement corpus, curtailing living expenses.

These two real-life instances underline why every individual needs to plan for retirement. Besides inflation and the desire to increase our standard of living, longer life-spans may require us to fund a longer retired life.

With governments globally scaling back defined benefit retirement plans, individuals are left to fund their own retirement.

Step 1: Customise your retirement plan

Bonds, fixed deposits and traditional insurance all generate regular income but fail the inflation test. On the other hand, beating inflation often involves taking on higher risks; and volatility causing risk-averse investors to abandon their investment plan midway.

This is why you need to arrive at your tolerance for losses, essential to invest in risky assets such as equities. So, rather than following stereotypes to reach a retirement corpus, individuals should construct a portfolio based on their life-style, time horizon and risk appetite.

Step 2: Evaluate your ability to save

The starting point in planning for retirement is evaluating how much you need to save every month. Gone are the days when individuals retired only at 58 or 60. Many of us cherish the dream of retiring in our forties! So next step in arriving at your retirement corpus is deciding how long you may continue to work.

If your working life is shorter than retired life, then you obviously need to save more. For instance if you decide at 30 to retire at 45, with a corpus of Rs 4.5 crore you ought to save a sum of Rs 90,000 per month and it should earn a return of 12 per cent. But if you wish to retire at 58 then you need to save monthly a sum of Rs 16,475.

While constructing a retirement plan, do remember that women outlive men, hence plan your corpus based on your wife’s life expectancy rather than your own.

You will also need to save more if you want to reach your retirement corpus mainly by investing in debt or safe investment options. Remember, most of the safer or guaranteed investment options fail the inflation test, which may impact your standard of living at retirement.

Step 3: Arrive at how much you may need

How big a retirement corpus you need will depend on several factors: your current living expenses, inflation, your need to improve your standard of living and likely expenses after retirement.

Take living expenses first. Say, an individual who is 30 years old, with current monthly household expenses of Rs 30,000, wishes to accumulate a corpus for his retirement by 58. He also wants to improve his standard of living post retirement.

At a 7 per cent inflation rate every year, his current monthly expenses of Rs 30,000 will be Rs 2.1 lakh, 28 years hence. Assuming his life expectancy is 80 years, to have a monthly pension of Rs 2.1 lakh, one needs to have Rs 4.5 crore as corpus (we have not factored the tax on investment return), earning inflation adjusted returns of 2 per cent (if the inflation is at 7 per cent you should try to earn 9 per cent).

To accumulate Rs 4.5 crore in the next 28 years you should save monthly a sum of Rs 16,458, earning a return of 12 per cent. If you wish to increase your standard of living by increasing living expenses by just two per cent, the retirement corpus will jump by more than 50 per cent to Rs 7 crore! If you will receive regular pension from your employer or have rental property that can generate regular income, these can be reduced from your living expenses to compute your requirements.

Medical expense is another major factor that needs to be accounted into your retirement calculations. If you have adequate health covers for major diseases, with an additional sum towards out-patient treatment that may protect your savings to some extent.

At least four years before retirement, do ensure you have adequate health insurance, with cover for any pre-existing ailments. If you have travel plans after retirement, that too will add to the targeted retirement corpus.

Step 4: Decide on allocations

Asset allocation is deciding how to invest your surplus across debt, equity, real estate and other assets such as gold, based on your targeted return and risk appetite. This portfolio should be able to generate the desired return.Once the return target is fixed, it is then easier to identify the mix of investments that can deliver the return. Over the long term, equities have proved to be the best asset class to beat inflation. However, in the last ten years, gold too has performed in sync with equity to deliver a compounded annual return of 18 per cent.

Let us consider an individual in his 30s who wishes to achieve 12 per cent return on his portfolio. Due to a long accumulation period, he invests 50 per cent of his surplus in equity, 20 per cent in debt and real estate and the balance in gold. Assuming you construct a portfolio with an expected return of 15 per cent in equity, 12 per cent in real estate and 8 per cent in debt and gold respectively. This portfolio would deliver a 12.3 per cent return.

In contrast, if the equity proportions were to be reduced to 30 per cent and the rest in debt and gold increased accordingly, the return would only be 10.1 per cent. This highlights the need for proper asset allocation to achieve the desired results.

Step 5: Meeting any shortfall in the corpus

There is no guarantee that your portfolio will indeed earn the rate of return you assumed in your original calculations. It is, therefore, very important to re-evaluate your portfolio on a regular basis to see if you are on track. The first step to make sure there is no shortfall is to enhance the contribution to your retirement kitty, when there is a jump in your pay.

If you still have a shortfall by retirement, those who own property can explore the reverse mortgage option (a loan available to senior citizens against mortgage of property) to meet their monthly requirements. Do take term insurance to ensure your spouse has sufficient income for rest of her life, if she outlives you. ~END~

Retirement Planning, Senior Citizens, Certified Financial Planner – Chennai, Savings, Investment Advisors, VRIDHI, Vivek Karwa

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