Throughout your working years, you must save and establish a significant corpus to satisfy your retirement income demands. Regrettably, many investors in our nation do not prioritize retirement planning until they reach the later phases of their careers. In this two-part blog article, we’ll examine retirement planning.
What is the significance of retirement planning?
In a joint family, the earning members secure the financial stability of all family members. Nuclear families must have a retirement plan in place to provide financial stability upon retirement.
Employees covered by their companies’ pension programs continue to receive income after retirement. However, the overwhelming majority of Indians do not get a pension upon retirement. You must generate your pension via the cash flows generated by your assets.
The average lifespan is growing, and retirees are living longer. Additionally, you must protect your spouse’s financial independence if he or she survives you. A person’s savings or investments must be adequate to guarantee a steady income for an extended period.
Inflation should be included in retirement planning. Your living expenditures will continue to rise over time. Your retirement fund should produce sufficient cash flow to cover inflationary expenditures.
You may be compelled to retire early for several reasons, including forced retirement, bad health, or the need to care for unwell family members. It is advisable to begin preparing for retirement early in life to be better equipped to deal with unanticipated financial difficulties.
Financial self-sufficiency
The primary goal of retirement planning is to preserve financial freedom. How can you get financial self-sufficiency?
If the income generated by your assets is sufficient to cover your costs, you are considered financially independent. You should comprehend what we mean when we refer to “assets” in this context.
Assets are investments that create income or returns for the owner. Mutual funds, bank FDs, stocks, bonds, and rented property are all examples of assets. The home in which you and your family reside, the gold jewellery you/your spouse want to wear or present to your children/grandchildren, and your personal automobile are all examples of assets that do not create revenue for you.
We shall use the term “assets” or “investments” in this blog post to refer to just those assets or investments that create cash flows for you. If your assets do not produce enough income to cover your costs, whether due to inflation or excessive withdrawals, you will eventually lose financial independence and must rely on others, such as children, grandkids, or other relatives.
How to make retirement plans
You should estimate your post-retirement costs. If you have a mortgage and intend to pay it off completely before retiring, you are not required to budget for EMIs. If you are paying school or college tuition for your children and anticipate that they will begin working careers before you retire, you may deduct those costs. Several of your present expenditures (for example, food, utilities, fuel, staff pay, maintenance and service, and so forth) will remain after retirement. Many individuals anticipate that their expenditures would decrease significantly after retirement, but our experience indicates that the majority of your expenses, except house loan EMIs and children’s school fees, will remain even after retirement.
Inflation should be included in retirement planning. Assume you want to retire in 20 years and your present monthly or annual living expenses, excluding those that would be eliminated upon retirement (e.g. house loan EMI, children’s schooling, etc.), are Rs 50,000 per month or Rs 6,00,000 per year. Assuming 4% inflation, your yearly expenditure will be around Rs. 13,00,000. (Rs. 13 lakhs per annum).
How much money should you accumulate? Following retirement, you should maintain a risk-averse profile. You should not anticipate an annual pre-tax return on investment of more than 5%–6%. (ROI). If your effective yearly tax rate is 12.5 percent (e.g., you earn between Rs. 12.5 and Rs. 15 lakhs), your post-tax return will be between 4 and 5 percent. If you want a yearly income of Rs. 13 lakhs, you would need a corpus of Rs 2.6 – 3.2 crores, assuming a 4% – 5% after-tax withdrawal rate per year. We have assumed in this section that you have no other source of income than your assets. If you have other sources of income after retirement, such as rental income from a rented property, pension income, or income from professional services (e.g. consulting), you may deduct them from your costs when calculating the income required from assets.
We have assumed in the preceding example that you will leave your whole corpus as an estate (i.e.as an inheritance) to your loved ones, such as children, grandkids, and so on, and that you would live solely off the returns. If you want to leave a little estate or none at all, you may increase your corpus withdrawals. In such a situation, a smaller corpus will suffice. However, you should bear in mind that if your withdrawal rate exceeds your return on investment, your corpus will continue to depreciate over time. Your withdrawal rate should be such that your corpus does not reduce to zero over your lifetime and that of your spouse. This will be discussed in more depth later.
Thus far, we’ve explored the effect of inflation on your retirement savings. Because your costs will continue to rise after retirement, you will want more income in subsequent years. How can you increase the income generated by your assets, even though you withdraw funds regularly to cover your expenses? Capital appreciation is the solution. Even after retirement, you must maintain a portion of your asset allocation in stocks. Equity as an asset type has historically provided greater inflation-adjusted post-tax returns.
The next question will be “How much stock should you include in your asset allocation upon retirement?” Your stock allocation will be determined by your risk tolerance, corpus size, and income requirements. As a general guideline, the Asset Allocation Rule of 100 may be used. According to the Rule of 100, your equity allocation should equal 100 minus your age. Therefore, when you reach the age of 65, you should have 65% of your assets in fixed income and 35% in equity. The following table illustrates proposed asset allocations for various post-retirement ages using the Rule of 100.
The Hundredth Rule
Suggestions for further reading: What should be your optimal asset allocation & why is it important?
The conclusion of this section
One area of retirement planning that we did not touch on in this piece is lifestyle planning since lifestyle requirements vary by person. However, lifestyle concerns are critical when budgeting for retirement. Your retirement plan should allow you to continue your current lifestyle after retirement, since changing one’s lifestyle is quite difficult.
Our goal with this essay was to provide you with some broad guidelines on how to approach retirement planning. Consult your financial adviser to determine the amount of money you need to save and invest to attain your retirement objective. The next part of this series will explore how to approach retirement planning using mutual funds. For the time being, you may read about why you should begin investing in mutual funds early in your retirement planning.
Mutual fund investments are subject to market risk; thoroughly read all plan papers.
