As individuals are expected to live for 15-20 years post retirement, it becomes essential for an individual to financially secure his golden years. Added to this is the rising medical cost, which is running way ahead of the normal inflation, and the breakdown of the joint family support system.
Most working individuals in their early thirties may not even think of a life after retirement. By the time they get into their forties, the thought of retirement settles in and then begins the planning - one of the key challenges here is to make up for the time that is lost due to lack of planning early.
For example, if an individual spends Rs 25,000 a month today, at an inflation of 7 per cent, the expenses after 25 years would increase to Rs 1,36,000. Add to this medical expenses, which increase with age and other expenses - the monthly expenses could actually exceed Rs 1,50,000.
Planning for retirement is a systematic process, the earlier one starts, the better it is, as this gives one the opportunity to regularly save to build a corpus. The benefit of time coupled with the power of compounding helps to create a substantial retirement corpus.
There are two key phases in the retirement planning activity - the accumulation phase and the annuity or payout phase. In the first one, the individual contributes a certain amount regularly. The annuity or payout phase is when the pension is paid out. The age from which one starts receiving pension is called as the Vesting age.
HOW MUCH DO I NEED?
A systematic approach makes it easier to estimate the amount required after retirement and accordingly select an appropriate financial savings instrument.
Analyse: Assess current income, expenses, medical history and lifestyle requirements.
Calculate: Based on the current expenses, calculate the amount which will be required to financially support oneself and the family, after retirement. Companies offering pension products have retirement calculators on their websites which can help one to calculate the quantum of money required post retirement for financial independence.
Save: Regularly start saving a predetermined amount of money that will help you build the desired corpus for life after retirement. It is advisable to put aside a portion of your income as savings before expenses, rather than saving what is left after expenses.
Let's see how much one needs to invest for a monthly income of up to Rs 40,000, post retirement.mosimage
While the amount required to be invested is higher if retirement planning is delayed, the significance of 'regular investments' cannot be understated. It is only through a disciplined approach that one can build a corpus that will generate regular income to enable one to live a life of financial independence after retirement.
WHAT ARE THE INSTRUMENTS I CAN USE?
There are various products available - Employee Provident Fund (EPF), Public Provident Fund (PPF), New Pension Scheme (NPS), Unit linked plans by life insurers and Mutual funds.
UNIT LINKED INSURANCE PLANS: Market-linked plans are cost effective over the long term. These are very beneficial to the customers during the accumulation phase, and also provide a life cover. Customers can choose the asset allocation based on their risk profile. It is strongly advised that customers view these products from a long-term lens as they have the potential of delivering high returns due to the mix of debt and equity. Customers can also switch asset allocation between debt and equity and ensure an optimal mix to derive superior returns. Historical evidence has proven that equities offer a superior rate of return over the long term. Unit-linked products have a lock-in of five years, which works in favour of the customer as it instils a disciplined approach to making regular contributions. Over a period of 10 years the costs reduce significantly, which aids in building a large kitty. While the customer enjoys tax benefits on the regular contributions made during the accumulation phase, the maturity amount is taxable in the annuity phase. The primary reason these plans score less on popularity is due to customer unfriendly tax regime.
MUTUAL FUNDS: Mutual funds too are a good vehicle, to build a retirement kitty, due to the exposure to equities. Liquidity in these products is high. However, it is not advisable to use this option as it will disrupt the corpus building process. Regular contributions in the accumulation phase do not provide any tax benefits, except for ELSS products.
NATIONAL PENSION SYSTEM: This product invests in equities, corporate bonds and government securities, and permits the subscribers to choose the asset allocation of their choice, with a cap of 50 per cent on equities. Exposure to equities could provide potentially higher returns over the long term. Withdrawal is limited to a maximum of 60 per cent on retirement and an annuity has to be mandatorily purchased with the balance 40 per cent. In case of withdrawal from the scheme before retirement, maximum of 20 per cent is allowed and with the balance 80 per cent of the corpus an annuity can be purchased.
EMPLOYEE PROVIDENT FUND: Employee Provident Fund is primarily for the salaried people, where the individuals contribute 12 per cent of their basic salary plus dearness allowance and an equal amount is contributed by the employer. The EPF funds are exclusively invested in low-yielding government securities for a guaranteed return. Savings invested in EPF grow at a slow pace as 100 per cent investment is made in government securities/debt instruments, which at times do not beat inflation.
PUBLIC PROVIDENT FUND: Public Provident Fund is a 100 per cent debt-oriented investment, guaranteed by the government of India. A minimum contribution of Rs 500 a year is mandatory. This product has a lock-in of 15 years. Partial withdrawals are permitted from the sixth year subject to certain conditions.
While EPF and PPF have been providing returns ranging between 8.5 and 9 per cent (the current returns for 2014/15 are 8.75 per cent and 8.70 per cent for EPF and PPF, respectively), the other pension products have provided higher returns primarily due of the exposure to equities. The below table depicts the performance of equity markets, the probability of positive returns and the expected returns from a regular annual investment of Rs 20,000 in equities.mosimage
Tax benefit of up to Rs 1.5 lakh is available under Section 80C of the Income Tax Act for investments in ULIPs, NPS, EPF, PPF an additional exclusive benefit of Rs 50,000 has been made available for NPS under Section 80 CCD(1B).
EPF and PPF are tax free on maturity. For NPS the entire proceeds are taxable. Maturity amount of unit-linked plans are tax exempt provided the sum assured is 10 times the annual premium. An individual needs to ensure that their retirement planning portfolio comprises of a mix of products mentioned above. The key is to start early, make regular contributions and remain invested till retirement age.
(The author is Executive Director, ICICI Prudential Life Insurance Company Limited)