Mr. Sharma recently turned 75 and received many wishes for a long and healthy life including some wishing him to live beyond 100. However, Mr. Sharma was concerned about his expenses as his income from assured returns products was declining. When he retired 15 years ago, he was confident that the interest income from his corpus (provident fund and other investments) would suffice over his retirement, but he had never imagined that interest rates would decline so quickly.
While we imagine retirement as living without any strings attached, it is not as easy as we think. How we manage our finances during our active life, decides how we can lead our golden years. The higher the retirement corpus accumulated over our earning years, the easier our retired life can be.
Plan early for retirement
You have a 35-year career till you retire at age 60. Owing to the advancement in medical science, life expectancy has touched 90 years which means you need to plan for 30 years of your retired life. The biggest contrast is that 35 years of your career was with a salary, while 30 years of your retirement will be without a salary. Another contrast is due to inflation.
Say, your expenses were ₹1 lakh at age 40, the same expenses will be ₹2.65 lakh at age 60 due to inflation of say 5% and ₹7 lakh at age 80 and ₹11.5 lakh at age 90. In short, expenses are likely to grow over 11 times in 50 years due to inflation. These numbers may sound astronomical but they will be very close to reality if inflation grows at 5% p.a. Hence, we must generate a large enough corpus which survives inflation as well as outlives our golden years.
Building a retirement kitty and managing it smartly
There can be two key pillars to build a large enough retirement corpus:
1. Starting early
2. Having an allocation to Equity/Equity Mutual Funds.
The first helps to compound your money over longer periods and the second can help to fight inflation owing to the potential to generate higher returns. For instance, a 25-year old may be able to build a retirement kitty of over ₹5 crore by age 60 by investing ₹10,000 monthly via systematic investment plans (SIP) in an equity mutual fund assuming returns of 12% pa. If the SIP is stepped up by 5% pa, the retirement kitty could grow to more than ₹8 crore. But a 5-year starting delay could see the SIP corpus drop to ₹3 crore and step-up corpus drop to below ₹5 crore.
Building a robust corpus is only one part of retirement planning. You also need to be medically insured so that any major health related expenses post retirement are borne by the insurance company and not spent from the corpus. Like an SIP, insurance at an early age helps to optimise premiums.
The third part of retirement planning is to ensure that your corpus is able to survive for at least 30 years post retirement and outlive the last surviving partner. To meet this objective, part allocation of the portfolio in accordance with risk taking ability to equity mutual funds even post retirement can help to beat inflation.
While mutual funds are more known for accumulation via SIPs, they can also help to decumulate or provide regular income via systematic withdrawal plans (SWP). An SWP is also more tax efficient as the tax outgo in case of SWPs can be lower than that from interest income from traditional deposits. Remember that the latter are taxed every year based on accrued income while mutual funds are taxed only when gains are redeemed and not just accrued. Investors may choose from among a variety of hybrid funds, asset allocation funds, balanced advantage funds and debt funds to start their SWPs.
In a nutshell
Retirement planning needs to be conceived not closer to retirement but much earlier. If Equity allocation is continued even beyond 60 years may reap benefits (though it may gradually reduce over time). SWP offered by mutual funds are a tax efficient way of enjoying regular income during retirement. Retirement planning is important as you can be young without money, but you cannot be old without it.
Satish Prabhu is the Vice President & Head of Content at Franklin Templeton India