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For the Long Haul

twitter-logoDipak Mondal and twitter-logoChandralekha Mukerji    Delhi     Print Edition: October 2011

If you are complacent about retirement planning, let's try to shake you out of your slumber. How much do you need at retirement to maintain the same lifestyle that you have at present?

If your monthly expense is Rs 30,000, and you retire 30 years from now, you will need Rs 1.80 lakh every month, assuming that the annual inflation rate is 6%. Even if you can manage with 80% of your present expenses, that is, Rs 24,000, you will need Rs 1.44 lakh every month.

EXPERT TIP:How to select a retirement plan

There's more. If you live till 85-with rising living standards and progress in medical science, this is a conservative estimate-that is, for 25 years after after retirement (assuming you retire at the age of 60 years), the value of the nest egg you need to build is a staggering Rs 4.5-5 crore. This if we assume 6% annual inflation and 12% return on investment before retirement. If we assume 8% inflation, the corpus required is a mammoth Rs 12 crore.

Now, let's talk about the good part. You can achieve these goals with ease. We explain how.

Be an Early Bird

The earlier you start the better it is. One mistake people make is to defer retirement planning till it's very late. For most, it means just contributing towards their Employee Provident Fund (EPF) or Public Provident Fund (PPF) accounts. Either they do not correctly estimate the amount they will need at retirement or are focused on just short- to medium-term goals such as buying a car or a house.

An early start means you will have to save a lot less to create the same corpus. Calculations show that if a person starts saving at 25, the monthly outgo will be Rs 9,700 if he wants to build a corpus of Rs 6.3 crore at retirement if the rate of return is 12%. If he starts 5 years later, he will have to save Rs 17,800 every month to build the same corpus.

An early start also gives you the freedom to take risks. For instance, equities, though risky, give higher returns than other assets-gold, debt and real estate-in the long run. In the last 31 years, equity markets (Sensex) provided a compounded annual growth rate (CAGR) return of 16.85%, which is higher than other asset classes.

EXPERT TIP:Mutual funds best to build retirement kitty

You can invest a large chunk of your money in equity or related instruments if you start early. For example, if your horizon is 25-30 years, you can invest 70-100% savings in stocks. As you approach retirement, you can start liquidating these high-risk, high-return equity investments and go for the safety of fixed income options such as debt funds, bank fixed deposits and PPF.

Focus Hard

The key to retirement planning, say financial planners, is to keep it separate from short- and medium-term goals such as buying a house or children's education. Be clear that the corpus you are building is to be touched only after you stop earning. Not having specific goals leads to complacency, which means you may not be able to save enough.

Take Mr X, who invests Rs 25,000 a month in various equity mutual funds through systematic investment plans but has not made separate allocations for different goals. He expects to have Rs 4.8 crore when he retires after 25 years. A corpus of Rs 4.8 crore seems big. But can it ensure financial security, given that Mr X expects to buy a house worth Rs 65 lakh and spend Rs 40 lakh on daughter's education and marriage?

Therefore, it is necessary to estimate the money needed for each financial goal and invest accordingly.

To calculate the amount you will need at retirement, first calculate your average monthly expense. Let's assume it is Rs 30,000 or Rs 3,60,000 a year. Add another Rs 40,000 as miscellaneous expenses and the annual total comes to Rs 400,000.

If inflation is 6% and you expect to retire after 30 years (at the age of 60), your annual expenses at the time of retirement will be:

Rs 4lakh x 1.0630 = Rs 22.97lakh
Formula: E x (1+r)N
Where E=Yearly expenses, r=rate of inflation,
N=Years left to retirement

 
If your investments earn 12% annually in 30 years before retirement and the inflation rate is 6%, the real rate of return is 6% (12-8%).

The corpus required at the time of retirement is yearly expense at the time of retirement/real rate of return (6% or 0.06)

Rs 22.97 lakh / 0.06 = Rs 3.83 crore

Let's assume that if you live till 85, that is, 25 years after retirement, and net inflation is 2%. The total corpus in this case should be:

Rs 3.83 lakh x 1.0225 = Rs 6.3 crore

Now comes the million dollar question. How to build such a corpus? Which assets can take you to the target? Let's see how much monthly investments are required to create a corpus of Rs 6.3 crore. (See table Towards a Rs 6.3 cr milestone on pg 26).

Where to Invest?

The market is flooded with products whose makers try all the tricks in their bag to make you believe that their plan is the answer to all your needs. Ensure that you don't get carried away by high-pitched marketing campaigns. Don't go for products you don't understand. Check if the product can give you the desired returns and matches your risk profile. The idea is to keep it simple.

Here, we discuss different products and see if they can help you build a nest egg big enough to last your lifetime.

Mutual funds: These are considered the best products due to the sheer variety of schemes that suit every profile, low costs, tax benefits and professional management. Equity mutual funds, which invest up to 100% money in stocks, can easily give 12-15% returns a year on an average in the long run. This makes them ideal for those with a high risk appetite.

Those with slightly lower risk-taking ability can opt for equity-oriented hybrid funds, which invest 65-70% in stocks and the rest in fixed income securities such as bonds and treasury bills.

Long-term capital gains from equity mutual funds (with over 65% equity exposure) are tax-free, making them all the more attractive.

Those with limited risk-taking ability, for instance people close to retirement, can go for debt funds, which invest in government and corporate bonds

Mutual funds offer the convenience of investing small sums at regular intervals-daily, monthly or quarterly. (For a detailed view on mutual funds as investment options for retirement read A Long Fund Ride Pg 32)

Ulips: Unit-linked insurance plans, or Ulips, combine features of insurance and investment products. A part of the money gets you a life cover while the rest is invested in equity or a mix of equity and debt. Ulips are similar to mutual funds in a number of ways except for the multitude of charges-allocation charges, policy administration charges, fund management charges and mortality charges. Hence, they are considered more expensive than mutual funds.

However, Ulip pension plans are pure investment vehicles. Since there is no insurance cover, the investor can save on the mortality charges.

According to guidelines by the Insurance Regulatory and Development Authority, Ulip pension plans must give a guaranteed return, though the rate of return can be decided by the insurer itself. To offer a guaranteed return, the companies play it safe and invest in debt. This, say experts, makes Ulips pension plans less attractive for those seeking high returns.

Investment in Ulip pension plans is eligible for tax deduction under Section 80 (c) of the Income Tax Act. The maturity proceeds are tax-free. The tax benefits will continue even under the Direct Taxes Code, proposed to be implemented from next year, which will take other Ulips out of Section 80 (C). Under this Section, one can claim tax deduction on investment in a number of saving instruments.

National Pension System (NPS): The NPS is a government-initiated retirement scheme. Under it, you have to contribute at least Rs 6,000 a year in a Tier-I account and a Tier-II account. The money in the Tier-I account cannot be withdrawn till retirement. There are no limits on Tier-II withdrawals. You need an active Tier-I account to open a Tier-II account.

You can choose three asset classes. Asset Class E, where the money is predominantly invested in equity and related instruments; Asset Class C, where money is invested in fixed income instruments other than government securities; and Asset Class G, where the entire portfolio comprises government securities. Under Asset Class E, the maximum equity exposure can be 50%. Except central government employees, others can choose any asset class.

The funds are managed by six companies-ICICI Prudential Pension Funds Management Company, IDFC Pension Fund Management Company, Kotak Mahindra Pension Fund, Reliance Capital Pension Fund, SBI Pension Funds and UTI Retirement Solutions. Investors can choose any of them.

Investments are eligible for tax benefits under Section 80C. However, the maturity amount is added to income and taxed accordingly.

Public Provident Fund (PPF) and Employee Provident Fund (EPF): The Public Provident Fund (PPF) is a government scheme under which you get an 8% annual return. The minimum investment is Rs 500 in a year while the maximum is Rs 70,000. The money is locked for 15 years. One can extend the account beyond 15 years in a lot of 5 years and withdraw up to 50% of the corpus after the 7th year.

In the EPF, one contributes 12% pay (basic plus dearness allowance), while the employer makes a matching contribution. All establishments that employ 20 or more people have to offer this benefit to employees. The rate of return keeps changing and is decided by the central board of trustees of the fund every year. At present, it is 9.5%. The amount can be withdrawn on retirement or while leaving the organisation. In the latter case, there is the option of transferring the money in the account opened with the new employer.

PPF and EPF investments are deductible from the taxable income under Section 80C. The redemption amount is not taxable.

You can also invest directly in stocks and bonds or go for bank fixed deposits.

However, you must carefully evaluate the risk-adjusted returns from each investment product and its ability to help you achieve the target. The concept of risk-adjusted returns evaluates returns from different investment products on the basis of risks that are taken to get those returns.

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Corpus for Different Age Groups

As you approach retirement, you should increase exposure to less risky investments as the number of working years is less and you need to protect the corpus you have built from the vagaries of the equity markets. Therefore, you need to rebalance your portfolio as you cross different age groups. There is no strict demarcation as an investment portfolio is a function of one's risk-taking ability, existing investments, income, expenses and financial goals.

However, based on our interactions with a number of financial planners and investors, we bring you ideal portfolios for four different age groups: 18-25 years, 25-35 years, 36-45 years and 46-55 years.

Age 18-25 years: You start your career, you have no liabilities and dependents. Though your income is less, so are the expenses. You have time on hand and can afford high exposure to equities. Ideal portfolio should have 85% equity, 10% debt and 5% gold.

Age 26-35 years: Your income increases and so do your liabilities. You are still far from retirement and can have high exposure to equities. Since you have more liabilities now, you should increase fixed income investments for a cushion against the volatility in equity markets. You should have equity, debt and gold in 70:20:10 respectively.

Age 36-45 years: Your liabilities increase faster than income. Hence, higher allocation to debt through PPF, EPF and debt funds is needed. Equities can still form 60% of your portfolio but you should go for large-cap stocks and equity funds. Debts and gold should be 35% and 5% respectively.

"This is the stage when one's earning graph moves upwards. However, one's responsibilities also increase. Hence, one must go for a judicious mix of liquid and growth assets," says Jayant Pai, VP & CFP, Parag Parikh Financial Advisory Services.

46-55 years: You are 5-15 years from retirement and need to protect the corpus from volatility. We suggest a 50:50 debt-equity mix.

Post-retirement Planning

You now have a sufficiently big corpus. The next step is to allocate it in a way that ensures both regular income and safety of investment. After retirement, it is advisable not to have more than 30% exposure to equities. Since you do not have regular income after retirement, liquidity should be a big consideration.

The ideal investment options after retirement are:

Senior Citizen Savings Scheme: As the name suggests, the scheme is for those who are 60 or above. It offers an annual return of 9%. The scheme has a 5-year tenure. The minimum investment is Rs 1,000 and the maximum is Rs 15 lakh. Investments are eligible for tax deduction under Section 80 (C).

Premature redemption is allowed only after one year. The interest earned is subject to tax deducted at source.

Post-office monthly income schemes: The Department of Posts offers monthly income schemes for senior citizens under which one can invest a minimum of Rs 1,500 and a maximum of Rs 4.5 lakh for six years. The annual rate of return is 8%, which can be received monthly or quarterly.

Some banks also offer monthly income plans under which the interest earned is paid on a monthly basis. The rate of interest is the prevailing bank fixed deposit rate. The tenure can be 12-60 months. However, the interest earned is subject to tax deducted at source.

Mutual fund monthly income plans (MIPs): These are debt-oriented hybrid funds with 80-85% allocation to fixed income securities such as bonds and treasury bills, and the rest to equities.

The dividend announced by the funds is paid to investors on monthly, quarterly or half-yearly basis.

However, the dividend is subject to availability of funds. In adverse market conditions, funds may skip payouts.

Apart from the earlier mentioned products, one can also invest in bank fixed deposits, fixed maturity plans and liquid-plus schemes of mutual funds. (For a detailed coverage on post-retirement corpus read Be Wise With the Corpus, pg 27)

Insurance Post-Retirement

The ideal way to start your retirement life is by paying off all debts and liabilities. Since you are supposed to be free from all liabilities, and may not have dependents, you don't need any life insurance at this stage of your life.

However, since medical costs can account for a large part of your expenses, health insurance is mandatory. Ideally, you should buy this at a young age and continue it after retirement. This way you won't have to pay the high premium that insurers charge for selling a cover in old age. This will also ensure that there is no waiting period for pre-existing diseases.

EXPERT TIP:How to choose best health insurance cover for retirement years

In health insurance, life-long renewability should be an important consideration. "The ideal cover for individuals in Tier-I cities is Rs 5 lakh and for those living in Tier II cities is Rs 3 lakh at present cost," says Karthik Javeri, a certified financial planner.

Retirement is an important milestone in your life and planning your finances for that is a long process not to be left for later stages of your life. The key to successful retirement planning is starting early, evaluating post-retirement needs and going for products that not only help you reach the targeted corpus but also protect it from the vagaries of the market.

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