Why Retirement Planning is very important

Retirement planning is one of the most ignored financial goals in most Indian households even though it is the one of the most important, if not the most important life-stage goals for most families.

According to SBI Mutual Fund, India is expected to move from a predominantly young population to an aging population in the next 30 years. The elderly population of India will rise from 117 million in 2015 to 317 million in 2050, which is an increase of almost 200 million in just 35 years. You can see the detailed presentation here

To help Indians plan for their retirement, SBI Mutual Fund has launched a new fund offer (NFO)– SBI RETIREMENT BENFIT FUND – from January 20^th – February 3^rd 2021.

In this blog post, we will discuss the importance of retirement planning, how to go about it in both the accumulation and distribution stages, and mistakes one should avoid in retirement planning.

Why you need to have a retirement plan?

• Working lives are increasingly getting shorter. With more focus on higher education and professional training, the average age at which one starts to work is more than what it was a generation back. People are also retiring at an earlier age, voluntarily or involuntarily. Health issues can also force people to quit working much earlier than official retirement age. Your working life is the period in which you save for retirement. With working lives getting shorter, retirement planning becomes more challenging and assumes greater importance.


• Nuclearization of families implies no safety net after retirement. Joint families provided financial comfort to retirees since children would take care of retired parents in a joint family construct. Nuclear family is not just a social / cultural choice made by family members – it is often driven by economic and professional needs. Even if children wanted to take care of parents, the burden on them will be higher than in the past, due to higher expenses, children and parents living in different cities, maintaining different houses due to career requirements of children etc. Also with increasing longevity, one nuclear family could end up financially supporting for parents and eight grandparents. Even if both the spouses are working, this financial burden can be too much.


• Pension cover is either non-existent or inadequate. India is largely an unpensioned society. Most private sector employees have no pension cover. Even for Government employees, the age of defined benefits pension scheme is over. Even employees covered under Employee Pension Scheme (EPS) and National Pension Scheme (NPS) may find it difficult to maintain financial independence and lifestyle over a long retired life as the Employee Provident Fund (EPF) corpusis usually too small to last for 20 – 25 years of retired life.


• Retirement savings will have to cover inflation. Inflation is one of the most important factors in retirement planning. Many investors wrongly assume that their post retirement expenses will be much lower than their current expenses. While some expenses like children’s education and transportation costs will go down, other expenses will increase due to inflation.
  
  If you are 30 years old and your current monthly expense is Rs 50,000, your monthly expense will be nearly Rs 2.3 lakhs when you retire at the age of 60 and Rs 5.7 lakhs by the age of 80, assuming inflation rate of 5%. Apart from inflation, certain types of expenses like medical costs will also increase with age. You need to accumulate a sufficiently large corpus to meet your expenses after inflation and other expenses.
  
  To know the future value of your current monthly expenses, use this calculator

How to plan for retirement?

• Calculate how much you need: After retirement your retirement savings will be your only source of cash-flows, apart from cash-flows from other assets e.g. rental income if any. Given increased longevity, you need to plan for retired life of 20 – 30 years which should also cover the financial needs of your spouse who may survive you. Carrying on with the earlier example, if you are 30 years old and your current monthly expense is Rs 50,000, assuming no changes in lifestyle, your monthly expense will be Rs 2.3 lakhs or annual expense of Rs 35 lakhs by the time you retire. If you are planning for a retired life of 20 years, you need to have a corpus of Rs 7 Crores by the time you retire. Your expenses will keep increasing after retirement due to inflation (see the chart above). However, if you invest your savings wisely after retirement, the returns on your investment will enable you to cope with inflation.
  
  Use this calculator to plan your retirement now


• Start savings and investment early in life: We saw in the previous example that you need to accumulate a fairly large corpus to be financial independent for the entire length of your retired life. In order to accumulate a large corpus without compromising on your lifestyle, you need to start investing early. By saving and investing early, you can benefit from the power of compounding. Compounding is interest earned on interest or profit earned on profit. The most important factor in compounding is time. The longer your money is invested, higher will be the power of compounding and wealth creation. Most families, especially salaried people, plan for retirement with their regular savings. You can reach your retirement goal with much less savings if you start early.
  
  Carrying on with our previous example, you need to accumulate a retirement corpus of Rs 7 crore. If you start saving for your retirement at the age of 25 or 30, you can reach your goal with much less savings compared to the savings required if you begin at the age of 45 or 50. The chart below shows the monthly savings required to reach the goal of Rs 7 Crore retirement corpus. We have assumed 10% return on investment in this example.
  
  You may check this tool to know how much monthly savings is required
  
  



• Saving is not enough, you need to invest. Saving money is essential to achieving your financial goals, but savings alone is not enough. You need to invest your money wisely to earn sufficient returns so that you can benefit from the power of compounding.
  
  The chart below shows the corpus accumulated through a monthly SIP of Rs 10,000 in Nifty 50 TRI and Rs 10,000 recurring deposit from 1^st January 2000 to 1^st January 2021. You can see that you would have been able to accumulate more than double the amount by investing in equity compared to traditional fixed income investments.
  
  

  Source: National Stock Exchange, SBI 1 year FD rates (1.1.2000 to 1.1.2021). Disclaimer: Past performance may or may not be sustained in the future.

  
  


• Consider tax consequences when investing: Taxes can take away a significant portion of your investment proceeds. Traditional investment options like bank FDs and several Post office small savings schemes are not tax efficient, since their interest income are taxed as per the income tax rate of the investors.
  
  Long term capital gains in equity mutual funds of up to Rs 100,000 are tax exempt and taxed at 10% thereafter. Long term capital gains in debt mutual funds are taxed at 20% after allowing for indexation benefits. In the distribution stage i.e. post retirement systematic withdrawal plan (SWP) may be a more tax efficient option than annuities. You may check here how SWP works


• Post retirement: This is the distribution phase of your retirement planning. Capital protection is important in the post retirement stage of life. Therefore, your asset allocation should be heavily biased towards fixed income. However, you cannot ignore equity in the post retirement phase because (a) post retirement life can be quite long and you can benefit from higher returns over long investment horizon, and (b) you may need equity returns to beat inflation over your long retired life. Equity investments can also help you in estate planning for your loved ones.

Mistakes you should avoid in retirement planning

• Do not over-extend yourself in debt: With rising cost of real estate and lifestyle aspirations in these days, debt is unavoidable for most households. But you should try to be debt free much before your retirement. Whether you are buying a house or car, plan your purchase in such a way that you do not have to compromise on your retirement planning in order to service your debt. Cost of debt (interest payments) is quite high in India and you should minimize your interest costs, either by taking a smaller loan or repaying the loan over a shorter tenure.


• Do not divert your retirement savings: This is a common mistake which many families make and in the long run fall short of their retirement goal. You need to be disciplined and committed to your goals. Having dedicated funds for different life-stage goals can ensure discipline and commitment. You should have a contingency fund to meet any unforeseen exigencies. Having such a fund will ensure that you do not draw from your retirement savings even in the face of emergencies.


• Not having adequate risk protection: Life can throw unpleasant surprises and you should be prepared. An unexpected serious illness or unfortunate death can cause financial distress. You should buy sufficient risk protection in form of life and health insurance so that financial security of your family is not jeopardized by unexpected risks.


• Avoid unproductive investments: Return on investment is one of the most important factors in your retirement planning. You should always put your money to work to earn more money on an inflation adjusted basis, net of taxes. Many families commit a lot of investments to low yield or high cost products like insurance cum savings plans. You should understand the costs and investment characteristics of products you invest in. Many investors may have unfortunately invested in high cost / low yield products and are continuing to invest. It is better to exit / surrender such products early in the product (policy) term rather than closer to maturity. Consult with a financial advisor if required.

Conclusion

Financial independence means that you do not have to be dependent on anyone to meet your expenses, be it your employer or your children. Financial independence essentially implies that cash-flows from your investments will be sufficient to meet all your needs for your entire lifetime. This is essence of retirement planning. It is never too late to begin retirement planning but an early start is hugely beneficial.

You can do your retirement planning with generic products or with dedicated retirement products like SBI RETIREMENT BENFIT FUND which offers four investment plans – • Aggressive (Equity oriented) • Aggressive Hybrid (Equity oriented) • Conservative Hybrid (Debt oriented) • Conservative (Debt oriented). You can choose a plan based on your risk appetite/ age.

Consult with your financial advisor if you want to understand more about your retirement planning. Download Scheme Information document and Key information Memorandum