The Top 5 Retirement Planning Mistakes That You Can Avoid

You are in your late twenties or early thirties and you have just started your family and you are too busy fulfilling the duties of a spouse and a parent. Among the household responsibilities and more nearer financial goals such as purchase of a vehicle and a home, plan for a vacation and children’s education and marriage; what is retirement planning and why should you bother yourself with the thought of it does not come to your mind. Stated below are the top 5 retirement planning mistakes that we usually make:

Looking at the short term

Usually when we retire we tend to think only for the short term. On retirement we typically think that we do not have many years to live and we wish that God calls us early. However, against our wishes on account of better health and medical facility the life expectancy of urban Indians have a longer post retirement life in contrast to a generation earlier.

According to the 2011 census report, the average Indian women lived 3 years longer than the men. The life expectancy at birth of a women increased by 2.5 years to 67.7 years and that of men increased by 1.8 years to 64.6 years by 2011 census. This number is even higher in the urban areas in contrast to the rural areas on the back of superior medical and health facility.

At the age of 60 when you retire you should at least look at investing from a 15 to 20 years point of view instead of a 3 to 5 years time frame. This tendency to lock your investment for a shorter period increases when the interest rates are near its peak. When interest rates are nearing its previous high usually the short term fixed deposits interest rates i.e. 3 to 5 years are usually slightly higher than the long term i.e. 10 years fixed deposits rates. On account of this slight difference we usually get greedy and opt for the shorter term with marginally higher interest rate.

Let’s say it’s the year 2013-14, you have just retired and you decide to put some of your retirement corpus in fixed deposits. During this time the short term rates of bank fixed deposits are hovering around 11.0% while the longer term is at 10.0%. For this 100 basis points difference we tend to opt for the shorter period. You have purchased a 3 year fixed deposit yielding you interest rate of 11.0%. In these 3 years the RBI and the government have been successful in controlling inflation and the market interest has dipped by 200 to 300 basis points. The year 2016-17 i.e. the present, your fixed deposit is about to mature and you are not getting a suitable instrument where you could invest your money as safely as earlier at almost the same interest rates. How would you have wished that you would not have been tempted by the marginally higher interest rates and invested for 10 years @ 10.0% instead of 3 years @ 11.0%.

Hence before investing you should look at which part of interest rate cycle you are in and understand the merits of long term investing instead of short term.

No bucket for investments

While accumulating money for any financial goal investors do not tend to compartmentalize the funds for each goal. The usual tendency is to invest to the maximum extent possible and then use as much money whenever required. This form of investing usually does not leave much or anything for one of the last goals of one’s life i.e. retirement. This form of no bucket investment or even mental accounting for investment for each financial goal may lead to disastrous results.

Further, investors tend to invest without having any mental picture of what would be their monthly expenditure at the time of retirement and based on that what is the retirement corpus requirement. An investor should derive the monthly expenditure at the time of retirement either at a premium or at a discount or at par with the present regular monthly expenditure and the average inflation they wish to assume over the accumulation period.

For example you are 40 years old and you decide to retire at the age of 60 during which inflation is expected to be 7% p.a. Your present monthly expenditure is Rs. 50,000 and you believe that by the time you retire your expenses would reduce by 10% from the present level. Based on this you could calculate your first years monthly retirement expenditure of Rs. 174,135 per month {(Rs. 50,000*(1+7%) ^20)*(100%-10%)} i.e. Rs. 20.90 lakhs p.a.

Refer https://www.advisorkhoj.com/tools-and-calculators/future-value-calculator

Additionally if an investor assumes the rate of return and inflation in the post retirement i.e. distribution phase and his approximate life expectancy, he could calculate the retirement corpus required. In continuation of the above example if we assume that the return during the distribution phase is 8% and the inflation continues to be at 7% (Real rate of return therefore being 0.93% i.e. ((1+8%)/ (1+7%)-1) during his life expectancy of 80 years, the corpus required when he is 60 would be Rs. 3.83 Crores (Rs. 20.90 lakhs *(1+0.93% )*(1-(1+0.93%)^-20)/0.93%).

Read financial planning for the retirees

Completely avoid equity

One of the most common mistakes that we make is to avoid investing in risky assets such as equity while planning for retirement. The psychology being that retirement is planning for old age and during that phase of life you should not take much risk. However, one forgets that though we are planning for old age, the age in which we are accumulating money for retirement is when we are young and we can take risk.

Though investing in equity depends upon the risk appetite of each individual, however, you have to remember that equity is the only asset class that helps you beat inflation by a high margin. The return on equity and equity oriented mutual funds, range from 10% to 15% depending upon the risk taken in each category, whereas we can say inflation in India has a long term average of 7%.

However low is an individual’s risk appetite, one cannot completely avoid equity if they wish to build a decent retirement corpus. As retirement nears one can steadily decrease the exposure to equity.

Here you must read retirement planning through mutual fund SIPs

As you approach towards retirement, mutual fund instruments like fixed maturity plans or monthly income plans (MIPs) can be a good option to protect your capital. Also, in order to meet your monthly expenses, you can also opt for Systematic Withdrawal option (SWP). It is said that money cannot buy all the happiness in life. Having said that, lack of financial security, does put a lot of stress in our personal lives. With proper planning and rigorous discipline, mutual funds can be a great investment option to ensure a very fulfilling retirement life

Not calculating future taxes and all taxation avenues, even if not valid now:

There is this common misconception that once you retire and as you do not earn any fixed income you are not liable to pay tax on anything. One should keep in mind that pension income, whether received from your previous employer or an insurance company, is taxable in the hands of the pensioner. Further any interest income received from fixed deposits, senior citizen saving scheme (SCSS), post office monthly income (PO MIP) are all taxable in your hands.

Similarly, if you withdraw some amount systematically from debt mutual fund schemes, then the gains are also taxable. If the sum of all these income increases Rs. 3.00 Lakhs (standard deduction for senior citizens) in a financial year, and if you have not invested any amount (maximum allowable र 150,000 per annum) in tax saving instruments under section 80C of the Income Tax Act 1961, then you need to pay tax as per the income tax slab that you are falling in.

Retirees should also buffer in all taxation avenues even if they are not taxable in the present but might be taxable later. For Example, until the budget 2016 all dividend incomes whether received from a company, equity oriented mutual funds or preference share dividends, was tax free in the hands of the investor. However from the fiscal 2016-17 any dividend income received in excess of Rs. 10.00 Lakhs from equity and preference shares, it would be taxable @ 10% p.a. Therefore, if a retiree does not keep aside money for such eventualities on account of changes in the taxation law or the structure itself, then calculations might get messed up.

Too many easily accessible funds

The tendency of humans to tap and use easily accessible funds is high, therefore, retirement being a long term goal if we do not lock in our investment, the inclination to consume those funds whenever the situation demands is high. Therefore, for any long term goals the investment should be locked in for some time or at least there should be a penalty / disincentive for withdrawing the funds before the due date.

If you invest in stocks or equity oriented mutual funds and you book profit before the period of one year then short term capital gains tax is applicable @ 15% on the profit amount. However, if you book profit in equity or equity oriented mutual funds, after a year then the whole profit is tax free in your hands as long term capital gains. Further, if you redeem funds from equity oriented mutual funds within one year from the date of investment then chances are that you will also be paying an exit load of 1% - 2%, thereby reducing the gains

Conclusion

One of the most common mistakes that we commit while planning for retirement is of not having any plan at all and thus investing haphazardly. Retirement planning is a very complex but a very important aspect especially in today's context as we are passing through a process of economic and social transformation. It is therefore, very important that we understand the fundamental financial goal of retirement planning, which is to achieve financial independence in your retired years.

Disclaimer: An Investor education and Awareness initiative of Aditya Birla Sun Life Mutual Fund.