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How to keep your retiral plans on track

LiveMint logoLiveMint 26-04-2017 Sunita Abraham

The retirement goal lends itself to multiple misconceptions and errors. You think you have a long time to save for the goal and so postpone it indefinitely, till it is too late. Or, you expect your expenses in retirement will be low and set a lower goal. Or, you focus on the urgent and immediate needs and leave the important retirement goal to drift along till it is too late to undo the damage done by procrastination and lack of direction. The biggest threat to the retirement that you dream of is inadequate funds. To mitigate this risk, pay attention to the major factors that can impact your retirement corpus. Here are some of these, and they are so vital that ignoring them will imperil your retirement plan.

Retirement is ideally suited to benefit from the advantages that compounding brings to accumulating a corpus. To take advantage of it, it is important to start early. A delay of just 5 years in starting saving and investing for retirement will translate into a 35% lower final corpus. Or, a delay of 5 years in starting to save for retirement could mean an increase of 50% in your contribution to reach the same goal. Procrastination can jeopardise your retirement plans.

Given the large corpus that you need to accumulate for retirement, every bit counts. If your employer offers to match contributions that you make to a retiral fund then make sure you contribute to the maximum extent possible. This will translate into a larger corpus from the higher contributions as well as the impact of compounding on the larger accumulation. Employer-sponsored retirement plans bring forced discipline to saving for retirement by deducting the contributions before the salary is paid to the employee.

The long investment horizon for a retirement goal means you don’t have to stick with low returns. Most retirement funds are invested in debt investments with steady but lower returns. While this may protect the principal, low returns will not protect the value of your money from erosion due to inflation.

The retirement investments should be diversified and include assets like equity for appreciation; and debt for stable returns in a way that reflects the available time to the goal as well as the willingness to take risks. The higher returns earned on the portfolio will counter the effects of inflation and enhance the benefits of compounding on the portfolio. Take the precaution to rebalance the portfolio towards less-volatile investments as retirement comes closer.

One of the primary reasons for an insufficient corpus is underestimating the expenses that have to be met in retirement. While some expenses, such as those related to profession and commuting, may come down; others such as medical expenses and money spent on leisure activities are likely to go up. The income replacement ratio, or the proportion of pre-retirement income required to meet expenses in retirement, will depend on the lifestyle chosen. Some people believe they will downsize in retirement and reduce expenses, while others may plan to live it up in retirement. It is difficult to accurately estimate the likely expenses in the early stages of retirement planning. But you will be leaving things to too late if you wait to have clarity before you start saving. Go with the thumb rules, one of which is: 70% to 80% of the pre-retirement income will be needed in retirement. This estimate will definitely change over time and you can make adjustments as you go along, so that the retirement goals reflect your current needs.

A common error in estimating the expenses during retirement is to overlook the impact of inflation. For example, something that costs Rs5,000 today will cost three times more in 25 years, if you consider an inflation rate of 5%. Ignoring inflation will mean that you are estimating expenses at a much lower level than what you will have to pay for during retirement. The effect of inflation does not end here but continues throughout the retirement period. Something that cost Rs15,000 at the beginning of retirement, would cost Rs31,000, or more, 15 years into retirement. The increase in costs, as a result of inflation in the period to retirement and through the retirement period, needs to be factored in for estimating the corpus required to meet the retirement needs. Ignoring inflation at either stage will mean that you are setting yourself up for running out of money, while you may still have years to live.

Consider the impact of tax at every stage in retirement planning. Post-tax returns is what you actually earn and this is the rate at which your corpus will grow in the accumulation phase. Post-tax return is the income you will have in hand to meet expenses in the distribution stage of retirement. Consider the tax implications of the products that you are considering, both to accumulate the corpus as well to generate income in retirement. In the accumulation stage, products where tax is deferred to the time of withdrawal should be preferred since they allow your entire contribution to earn and grow without any tax being deducted. In the distribution stage, look for products that allows you to maximize post-tax income.

Set clear goals and have a saving and investment plan for retirement. Revisit the goals and plans whenever there is a life event such as marriage, children and career shifts; so that the retirement plan is relevant to your current lifestyle and needs. You will be on track to enjoy the retirement you have earned.

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