Retirement Planning By Srinivasan Parthasarathy

An article published by Crisil mentions that the population of elderly (aged 60 and above) in India is expected to grow by about 200 million by 2050. A bulk of these people will have little to fall back on post retirement. Pension penetration is estimated to be at 30% in India which is far lower than its Asian peers which are at 70%. Why does this gap exist? Is it the lack of knowledge about planning for retirement or limited investment avenues to do so? Well, the latter certainly isn’t the case; so let’s delve into retirement planning to better understand how to approach it.

Now what is retirement planning? It’s the process of putting in place a roadmap for a care-free retirement. It’s about linking your current financial situation with your future plans and expectations. It’s about having a strategy in place to save money for your retirement in a systematic and disciplined manner to ensure an adequate income stream so that your post-retirement plans are unhampered. Why is this important?

In modern India, which is slowly moving away from the joint-family system to nuclear structures, it is becoming increasingly important for people to independently provide for their retirement needs as opposed to the earlier days when younger members of the family cared for their elders. The lack of an adequate or rather a more holistic social security system in India only exacerbates this problem. Now how does one go about planning for their retirement?

A retirement plan would require:

1. Identifying the various sources of future income
2. Estimating one’s future expenses – factoring in all expected costs depending on the lifestyle envisaged post retirement (must keep in mind both necessities like accommodation, food, medical expenses and so on as well as leisure activities like travel/trips and hobbies – all adjusted for inflation)
3. Assessing one’s ability to take risks – younger people planning for retirement say 30 years down the line could explore riskier investment strategies which would probably pay off over the long-run whereas older people with a shorter investment horizon should be more risk-averse
4. Selecting a portfolio of investments based on one’s risk appetite and financial objectives
5. Monitoring the retirement portfolio and churning it based on developing needs

There would be two broad phases in one’s retirement plan - the ‘Accumulation’ phase prior to retirement where one builds a corpus to fund his/her retirement needs and the ‘Decumulation’ phase post retirement where one draws down from the retirement-corpus to fund one’s lifestyle and other requirements in the absence of a direct source of earnings.

Both the above phases have their fair share of risks. During ‘Accumulation’, one maybe unable to build a sufficiently large corpus due to issues with market returns and volatility. During ‘Decumulation’, one may draw down from the corpus too fast such that it runs out beforehand or one may draw down too slowly and compromise on his/her lifestyle only to eventually leave a large portion of the corpus unutilized at one’s demise.

It is important to be mindful of one’s approach to both ‘Accumulation’ and ‘Decumulation’ and have a detailed plan in place for both these phases. There are multiple instruments available to reduce one’s risk exposure and strategically approach the above phases. They include:

During Accumulation: Public Provident Fund, Employee/Voluntary Provident Fund, National Pension System, pension plans offered by insurance companies, Atal Pension Yojana, solution-oriented retirement mutual funds and many others.

During Decumulation: Annuities, Pradhan Mantri Vaya Vandana Yojana, Qualifying Recognized Overseas Pension Schemes (QROPS), RBI retail direct scheme, Systematic withdrawal plans, Post office schemes and many others.

Most of the above instruments have tax advantages - the invested amount in a majority is tax-exempt within some pre-defined limits and there are also tax benefits on the interest earned and maturity amount subject to certain conditions.

To briefly touch upon some of the instruments:

1. Public Provident fund:

• Return: Declared by the government annually - latest declared rate is 7.1% p.a.
• Liquidity: Minimum tenure of 15yrs post which can be fully withdrawn – tenure can be extended in blocks of 5yrs, partial withdrawal* allowed post 7yrs
• Risk: Low-risk as government-backed
• Limit: Investible amount capped to a maximum of Rs.150,000 p.a.

2. Employee/Voluntary Provident fund (EPF/VPF):

• Applicable only for Salaried employees
• Return: Declared by the government annually - latest declared rate is 8.1% p.a.
• Liquidity: Complete withdrawal only on retirement or 2 months of unemployment, partial withdrawal allowed under special circumstances .
• Risk: Low risk as government-backed
• Limit: 12% of basic salary invested in EPF and up to 100% of basic can be invested in VPF

3. National Pension System:

• One can choose between Active and Auto investment options with varied exposure to equity, corporate debt, government bonds and alternative investment funds.
• Active Choice: Investors can choose their exposure to each asset class and modify the same. Maximum equity allocation allowed ranges from 50-75% based on age
• Auto Choice: 3 sub-funds available with a pre-defined asset mix which changes based on the investor’s age. Equity allocation ranges between 5-75%
• Return: Based on fund chosen
• Liquidity: Complete withdrawal only allowed at age 60 - up to 60% of corpus can be withdrawn and the remaining 40% must be used to buy an annuity, limited partial withdrawal options prior to age 60 under special circumstances.
• Risk: Based on exposure to above asset classes

4. Insurance-based pension plans:

• Return: Market-linked and non-market linked/guaranteed return options available
• Liquidity: Tenure can be chosen as per needs - minimum is 5yrs, premature exits are possible. On maturity/pre-mature exits, up to 60% of the corpus can be withdrawn and the remaining 40% must be used to buy an annuity
• Risk: Market-linked plans are exposed to market risk while non-market linked/guaranteed plans are low-risk plans

5. Annuities:

• Income payable throughout the life of a customer
• Return: Guaranteed returns (currently 6-6.5% p.a.)
• Liquidity: Surrenders possible for certain options
• Risk: Low-risk
• Multiple options - immediate/deferred income, with/without death benefit, fixed/increasing income etc.
• Joint-life options available wherein an annuity continues to be paid to the spouse after one’s demise
• Good retirement solution as one can pay premiums during the accumulation phase and receive income during decumulation.

6. QROPS:

• Overseas pension schemes that meet certain requirements set by Her Majesty Revenue and Customs (HMRC)
• Applicable for NRIs/POIs who were UK residents in the previous five tax years
• Allows the transfer of a UK pension fund to your new country of residence to be invested in a pension/annuity plan that suits your requirements

7. RBI retail direct scheme:

• Return: Based on prevailing yields (currently about 7.7% p.a. for a 40 year bond)
• Liquidity: Tenure ranges between 90 days and 40 years, can be sold before maturity but exposed to mark-to-market gains/losses
• Risk: Risk-free as it’s government-backed
• Can make a minimum investment Rs.10,000 - no upper limit

8. Systematic withdrawal plans:

• Mutual fund investment plans
• Return: Based on funds chosen
• Liquidity: Highly flexible withdrawals, could follow the 4% withdrawal rule but you run the risk of either draining out your corpus beforehand or under-utilizing it
• Risk: Market-risk based on chosen funds

To conclude, when it comes to retirement planning, there is no one-size-fits-all answer. You must choose a product that offers returns commensurate with your risk appetite and future requirements. Investing early is key so that you can plan for retirement well in advance but either way you’ve got to start somewhere. You must evaluate all the options available and select the one that best fits your current and future financial goals.