In this multi post series , I will be talking about one of the most important yet mostly ignored financial goals for many individuals, which is retirement planning.
Why retirement planning?
Retirement is going to be the longest vacation of your life. However, planning for retirement may seem a bit strange for many individuals. Many do not even consider retirement as a goal compared to something like buying a house or child marriage etc. For generations, Indians have depended on their children for retirement support.However, due to changing demographics and lifestyle, most youngsters are leading more independent lives far away from their parents. Often, they are unable to support their parents physically or financially. Even if they can do it, you might not want to be a financial liability for your children or depend on them to fulfil every want of yours in your golden period.Another major factor to consider while planning for retirement is that due to constant advancements in medical treatments year after year, the average lifespan is gradually increasing by almost 3 to 4 years every decade. Soon it will be on par with the more developed countries which are above 80 years. That means, many of us will be living almost 1/3rd of our life post retirement( of course without a salary!). Unlike many western countries, India doesn't have a robust social security system with retirement benefits for its senior citizens. Having a firm plan and a sufficient corpus will ensure that you have a peaceful retirement life and don’t become a financial liability for those close to you.
Chart 1: Life Expectancy over years
Retirement Planning Process
There are seven important steps in retirement planning. Let’s understand each step in detail.
1. Understanding what retirement mean to you
Understanding what retirement means to you is the first and most important step in retirement planning. You must picture what you want to do and how you want to lead your retirement life. Some say, I want to go for a world tour every year once. Some say, I want to live an ordinary life in my farmhouse. Based on how you want to live your life, your expenses will vary and the corpus needed vary from individual to individual.
2. Defining the retirement timeline
Once you define the retirement lifestyle, it is also important to define when you want to retire in the first place. Some want to retire early. For e.g at 50 years. Some still want to continue to work until 65 or 70 years. It is an individual choice.But from a planning perspective, you should roughly know when you want to completely retire where you don’t get any regular income.This gives an idea of how much time is left for you to accumulate the corpus. It’s never too early to start planning for retirement!
3. Knowing how much you need for your expected lifestyle
Once you figure out how you want to live your retirement life, and when you want to retire, it is easy to estimate what monthly expenses you may incur during your retirement period. Some of the expenses that you are currently incurring may continue even in your retirement period but with reduced spending(such as household expenses, travel or clothing etc). Some expenses may not be there at all completely post retirement such as children expenses like clothes or term insurance premiums. Some new expenses will also come in like frequent vacations, frequent outpatient doctor visits, chronic disease medications etc, gifts to grandchildren etc. According to your chosen lifestyle, you should make a list of all expenses that you may incur during your retirement. Apart from knowing your expected monthly expenses, you need three more things to determine your retirement corpus requirement.
i) Yours and your spouse assumed life expectancy
Always assume a higher expectancy as you don’t want to run out of funds during retirement. For e.g you plan for only 75, but you or your spouse lives for 90 years.
ii) The inflation
Inflation is a silent killer and slowly eats your corpus. Ignoring inflation is one of the biggest mistakes people make while preparing for retirement. The expenses at the start of the retirement and towards the end of the retirement are not going to be the same due to inflation. For example if Naveen is 35 years old now and spending 40,000 per month for living expenses. To have the same standard of living, assuming a conservative 4.5% inflation, Naveen will need 1,20,000 per month when he retires at 60 years age.
It is not the end of the story. Inflation will haunt you during retirement as well and if you want to maintain the same standard of living throughout the retirement, you must factor in inflation during the retirement. For example, at the age of 75, Naveen will need 2,32,000 per month assuming the same lifestyle.The numbers seem astronomical,
but it is the fact.
iii) Your expected rate of return during retirement
Retirement is a long period. You need uninterrupted regular cash flows throughout your retirement. You can’t risk losing your hard earned retirement corpus. What is the biggest risk during retirement?
Gambling with retirement funds? Yes, of course. What else? INFLATION!!!
you don’t want inflation to erode your hard earned money. At the same time you cannot put all your corpus in stocks or equity mutual funds.There are many strategies which can help you to earn higher returns than inflation and at the same time keep the portfolio stable. I will discuss more on this topic in the subsequent posts.
Once you have your monthly income requirement at the start of retirement and your life expectancy you can do simple maths to calculate how much corpus you need. Continuing the above example, if Naveen is 35 years old and wants to retire at 60, with 4.5% inflation he needs 1,20,000 per month.
If Naveen or his spouse is expected to live till 85 years, using the same inflation, and if we expect retirement corpus to generate 8% average return, then Naveen will need 2.4 core corpus when he retires at 60 years of age.
I will do a deep dive post in the subsequent posts on this step with an example and calculations.
4 Knowing your resources
Once you have a picture about your lifestyle ,possible expenses and required corpus, you need to understand what all the resources you may already have for retirement. For e.g you or your employer might be already contributing to EPF/EPS/NPS/Gratuity.You need to understand how much corpus you will get from these sources when you retire.
Many salaried individuals presume that their EPF/EPS contribution is good enough for their retirement.very few think about inflation and how much they might receive from their statutory contributions and how much they need. Some even do the costly mistake of early withdrawal of retirement corpus to fund short term goals such as house renovation. Situation is even bad for self employed individuals. They don’t have any statutory benefits and they are at the risk of entering a retirement period without much corpus forcing them to either depend on their children or reduce the standard of living.
5. Knowing the shortfall
Once you calculate the corpus needed in step 3 and available resources in step 4, you can realise if you have sufficient resources already for your retirement or if there is any shortfall. If there is a short fall, how would you want to bridge it? What are all investment avenues available? Answer to these questions depends on how far is your retirement from now. If you are staring at retirement in just 10 years or less, your options are less. You cannot invest aggressively; You don’t want to invest in highly volatile instruments such as stocks or equity mutual funds.Some of the conservative hybrid funds will help you here. If you have a 10 to 15 years of timeframe, you can take moderate risk and invest in balanced hybrid funds. If you have 15 years or more, then you can consider investing in a couple of good flexi cap funds.
Continuing the above example, If Naveen is expected to get around 1 crore from his existing retiral benefits (EPF + gratuity), then he needs an additional 1.4 crore funded from savings. He has 25 years of time left for retirement. Assuming average return of 12% on flexi cap funds, he just needs to invest 8,500 per month to bridge the gap. That’s the power of compounding and long term investment. Small but consistent contributions over a long period of time will create enormous wealth.
6. Planning the distribution
If you have done all the steps mentioned above and have been accumulating the
corpus for your retirement, congratulations! You are better prepared than almost 90% of people. However, there is one last step that you need to be aware of and careful about.
It is about how you plan to withdraw the money from the retirement corpus. For example, if you are accumulating corpus via equity funds, there is a chance that you will see volatility or correction in equity markets based on the then economic conditions just before the retirement or just after the retirement. It is referred to as sequencing risk.It is prudent to systematically move from high risk high volatility asset classes to low volatility asset classes at least two years before retirement starts. There are also strategies such as 3 bucket strategies which will help to avoid these types of risks if you plan carefully. I will do a detailed post on this strategy as well in the subsequent parts.
7. Last, but the most important: Insuring your retirement plan
Insurance is the most vital part of any financial plan. Retirement is a very long term plan. Anything can happen in between. Life is very uncertain. You don’t want to leave your partner/spouse's retirement in jeopardy if something happens to you. You should take sufficient term insurance to protect the financial safety and goals of your loved ones irrespective of whether you are around or not. Please read my post on term insurance below.
Summary
Retirement period is like a long vacation. In fact, it is almost 1/3rd of your entire life.
But, many are unprepared for this. It is in their lowest rank compared to other short term priorities. But, if you plan carefully by following the above steps and start early, with small but regular contributions you will be able to achieve your goal very comfortably. Even if you didn’t start early, it is never too late. You can still catch up with systematic planning and gradually increasing contribution. Hope this post is useful. In the next part, I will take an example and do an in depth retirement plan.Stay tuned. Please share your comments below.
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