Retirement is a very certain, distinct and significant phase of life. Sooner or later, we all need to retire. Despite the clear and present certainty of retirement, most of us relegate Retirement Planning to passive management. We do this assuming that there is not much to plan for retirement. We must not forget that retirement means reduced cash inflows without much reduction in expenses. The nature of expenses may change form, but money will still be needed.
Peculiarities of Retirement
(a) No income from job except income from pension/annuities and investments.
(b) Increased medical expenses.
(c) Requirement to sustain desired lifestyle.
(d) Expenses on hobbies and passions which could not be done/fulfilled earlier.
(e) Requirement of having financial independence.
(f) Limited scope of funding expenses from loans.
Ideal Conditions/Time to Retire
One might simply retire as a matter of time. Or we can choose to retire early as per our financial situation. It is therefore important to assess the desirable financial position at the time of retirement so that we can prepare by the due time. One can also consider early retirement if his retirement planning has been successful and he has been able to accumulate the required corpus. The desirable conditions are as under: –
(a) No liabilities. Retiree should have paid off all loans, or has earmarked appropriate asset for paying off the loans.
(b) Arrangement for pending financial liabilities. The present assets earmarked for the purpose should be able to cater for all financial objectives in near or distant future. We have discussed the aspect of articulating financial objectives in the article “Want to Create Wealth- But how much, and by When?”
(c) Arrangement for Healthcare. Healthcare assumes greater significance in old age. Govt and some corporate houses provide for free healthcare facilities to their employees. However, some might find it inadequate in terms of quality and accessibility. The healthcare insurance at this stage would also either not be available or be very costly. One should therefore earmark a separate corpus as per his/her assessment specifically for healthcare requirements of self and spouse.
(d) Adequate Nest Amount. Adequate retirement corpus to facilitate the desired quality of life. We should not include assets meant for financial objectives other than retirement corpus.
Factors determining Corpus for Retirement Planning
In order to estimate the size of appropriate retirement corpus, we need to work on the relevant factors as under: –
(a) Pension. Govt employees who entered service before 2004, are in receipt of pension as a defined benefit. Which means that the employee, without any further contribution, will receive pension as per terms and conditions of service. This is 50% of the last 10 months average pay and associated Dearness Allowance. In the case of others, it is defined contribution scheme, wherein the govt only contributes to the individual’s retirement corpus without assuring any benefit. The individual has to make his own contributions and control his pension benefits. The pension received would be based on the earnings of the accumulated retirement corpus at that point in time.
(b) Lifestyle/Expenses. Every individual has a different lifestyle which has its own cost. During retirement stage one would also like to indulge in some activities like travelling etc. which he could not do earlier. One needs to assess the cost of his chosen lifestyle to work out the corpus requirement.
Estimate of Corpus Requirement
As discussed earlier, the requirement would be different for each individual and it has to be worked in individual context. However, we can use some models to fairly predict the requirements. In my analysis I used two important variables to estimate the nest amount. These are the pension receivable at any given time, and the assessed annual expenses at that time.
The assumptions for these calculations are: –
(a) Individual is entitled to Govt Pension as defined benefit.
(b) Retiree commutes 50% of his Pension. Full pension is due for restoration after 15 yrs. The pension amount mentioned is the full entitled pension. The commuted portion can be counted towards the retirement corpus.
(c) Retiree can invest available corpus in assets which can generate post tax returns at minimum of 7%.
(d) Inflation is at 5% which will be mitigated by increases in DA on Pension up to the extent that the expenses are within the Pension amount. In case the expenses are more than the pension amount, than the impact of inflation on this extra expense has been factored in calculating the required value of corpus. One can see from the table that the corpus amount is significantly high if the annual expenses are more than the entitled pension amount.
(e) If there are any assured cashflows from rentals of owned property, or any other established source of income. Then one might reduce the expenses by that amount to identify the appropriate balance corpus requirement.
(f) The corpus requirement does not factor life expectancy. Portion of the corpus which outlives the retiree can be suitably factored in estate planning also.
Table Indicating Nest Retirement Corpus for different Pension and Expense Combinations.
Common Instruments of Retirement Planning
You can generally count the following assets towards retirement planning as their benefits at some stage will fund the expenses of retired life: –
(a) NPS Savings and any other annuities purchased earlier.
(b) PPF Savings.
(c) Endowment Policies yet to mature.
(d) Real estate other than for personal residential use which the retiree can liquidate if required.
(e) Gold assets in excess of personal requirement.
(f) All other financial instruments in the form of FD, Debt Funds, Equity Funds, Bonds etc. which have not been earmarked for any other financial objective. These would have been funded from life time savings and retirement benefits.
Scenario Analysis
Having seen the various factors and the estimated corpus requirement, one can face the following situations: –
(a) The present corpus (including retirement benefits) is more than the required corpus. In this case one is financially comfortable to retire, and can take a call as per his desire. It can be seen that in cases where the annual expenses are far too less than the entitled pension, the corpus amount required is zero.
(b) The present corpus is less than the required corpus. In such a situation one needs to continue to work. One should however see that as time increases, his expense levels will also rise. He should therefore keep his target corresponding to the estimated future expenses and not the present expense.
(c) The possibility of accumulating appropriate corpus seems bleak. This situation can occur due to many reasons, one of them is not having done timely planning for retirement. The options in this case would be: –
(i) Defer retirement to the extent possible.
(ii) Explore possibility of earning higher returns within
manageable risk levels.
(iii) Explore possibility of switching to a better paying job. One should however take a wholistic view of the uncertainties involved in moving from an assured Government job to the private sector.
(iv) Review the retirement expense requirement and calibrate lifestyle appropriately.
(v) Consider Reverse Mortgage. A significant portion of lifetime earnings goes in acquiring residential house. If one finds himself in financial distress during retired life, one can consider doing reverse mortgage. It involves selling of residential property in advance for a value. The retiree along with spouse can continue to enjoy the property for their residual life.
Conclusion
There are many factors which will influence the retirement planning. Someone with more social liabilities would find it difficult to reserve similar amounts as compared to person with lesser liabilities. Similarly, one with a modest lifestyle will need lesser corpus as compared to someone with a relatively costlier lifestyle. The issue of lifestyle inflation has been covered in the previous discussion “ Monetary and Lifestyle Inflation- The Silent Killers”. Further one should take care not to deploy the retirement funds in instruments with limited liquidity. Also products which have very little utility at that stage like endowment policies etc. should be avoided. One needs to constantly evaluate own financial position to balance the factors which affect the financial requirements of retired life. If the assets provide better returns, than these gains can be utilized for further improvement in quality of life.