"To achieve long-term wealth creation, one needs to be aware of two factors, the rate of compounding of investments and the time available for compounding" - Ashok T. Kanawala, head of products, training and business development at HDFC Asset Management Company
"Retirement is a concept that is more driven to 'capital protection' as a thought process" - Dinesh Rohira, founder and CEO, 5nance.com
"Each asset has its own highs and lows and this covariance of returns between asset classes makes construction of portfolio challenging and fruitful" - R. Raja, head of products at UTI Mutual Fund
While tax planning is an important component of retirement planning, it must not end up scuttling an ideal asset allocation and risk-return profile.
Of the many priorities that have traditionally dictated Indians' financial behaviour, planning for retirement has never been one. Indians have been content to assume that at the end of their working years, they will have a grateful and willing family to take care of them.
The experience of the last two decades, encompassing the collapse of joint families, the heightened migration and higher levels of inflation, however, has started changing it. “In the past few decades, the culture of our country has changed at a very fast pace. Earlier, most people lived in joint families and did not feel the need for retirement planning. Now we see more and more people moving to metros and big cities, and with constant increase in inflation and changing lifestyle, it is difficult for families to survive. We are witnessing a significant change in the awareness levels about the importance of insurance and retirement plans,” said Pradeep Pandey, chief marketing officer, Future Generali Life Insurance.
Other factors, too, have contributed to the growing importance of retirement planning. “With the increasing life expectancy and the fact that India lacks social security benefits as compared to many developed countries, each individual must take retirement planning seriously,” said Ashok T. Kanawala, head of products, training and business development at HDFC Asset Management Company. “Further, the standard of living has increased on an average, bringing with it the higher costs that continue to rise as per the inflationary trends, making it important to start saving for the retired life with target corpus in mind.”
Planning for retirement should begin early on to meet all these contingencies. But, when exactly? As early as possible, experts say unanimously. “It is pertinent to realise that retirement years are almost equal to working years,” said R.M. Vishakha, managing director and CEO at IndiaFirst Life Insurance. “With a life expectancy of 75 to 80 years, retirement age at 55 to 60 years, and an entry age of 25, a person works for 35 years and lives for another 20 years on the savings of these 35 years. Ideally, one should start planning for retirement by the time a person is 40, at the latest. The earlier, the better.”
The advantages of starting early are plenty. “Around 25 years is an appropriate age,” said Pandey. “This is not as difficult as it looks like. The key is to start small but invest for a longer duration as the effect of compounding returns helps grow the investment manifold. Planning for retirement is simply having enough funds post your working life to ensure that you do not compromise on your standard of living.”
Those who have missed the early bus can salvage it by strategising the investment. “It is akin to chasing a target in a limited-over match in cricket,” said R. Raja, head of products at UTI Mutual Fund. “Should you start early the chase and score uniformly or wait for the slog overs to accelerate, is your decision. Each strategy has its own pros and cons. The timeframe of the goal determines investment allocation. The timeframe is dynamic. The investment horizon for retirement planning when you are 25 is quite different from the same when you are 50. To cite an example, prior to retirement, even if your portfolio is performing well, you may have to move certain part of your portfolio to fixed income funds as it would lend stability to your portfolio and meet your retirement needs.”
Time is also important as compounding plays a crucial role in the building of the retirement corpus. “To achieve long-term wealth creation, one needs to be aware of two factors, the rate of compounding of investments and the time available for compounding. Fortunately, for people who wish to plan early for retirement, time is on their side. However, when it comes to the rate of compounding, it is up to each individual to choose investment options. Over a long period of time, say 30 years, the rate of compounding itself can determine whether a person retires rich or poor,” said Kanawala.
He illustrated the point with the example of a person who started saving for retirement at the age of 25 with a monthly investment of Rs 5,000. The total cost value of the investment till he reached 60 years of age would be Rs 21,00,000. On the other hand, a person starting to invest at the age of 35 would need Rs 7,000 to reach the same amount by the age of 60. “Assuming a compounding rate of 12 per cent per annum, despite the higher monthly investment, the person who starts at 35 would be able to build a corpus of only Rs 1.3 crore as compared to Rs 3.2 crore by the person who starts investing at 25. The key message from this illustration is that a delay of 10 years can be costly, and the retirement corpus can be lower by about 60 per cent,” said Kanawala.
A host of instruments are on offer for retirement savings. Among the traditional ones, the Senior Citizens Saving Scheme, the Post Office Monthly Income Scheme, and the Post Office Time Deposits are operated by India Post and work well for people in the lower-income bracket. The National Savings Certificate allows people to avail tax benefit on investments up to Rs 1,00,000 and offer an interest rate of 8.1 per cent. Other government-promoted instruments, such as the Public Provident Fund (PPF) Scheme, the Employees' Provident Fund (EPF) Scheme and the National Pension System (NPS) are suitable for the salaried middle class.
PPF is a tax-free savings instrument for investing in debt and the interest rate offered on it for the financial year 2016-2017 is 8.1 per cent. EPF is now almost a standard feature of the pension portfolio of every salaried employee in the country. Employer and employee together contribute 12 per cent of the basic salary into the EPF account, the corpus from which is invested by the Employees' Provident Fund Organisation (EPFO) in fixed income. Last year, the EPFO started investing 5 per cent of its corpus in exchange-traded funds tracking the BSE Sensex and NSE Nifty indices.
The NPS was originally envisaged as an instrument enabling government employees to take exposure in the financial markets. In 2009, it was opened to private sector employees as well. In the Union Budget for 2015-2016, contributions to NPS were given an additional tax deduction of Rs 50,000 under Section 80CCD of the Income Tax Act. In the last Budget, withdrawals from NPS on maturity were made tax-free for up to 40 per cent of the corpus.
These developments over time have signalled an intent on the part of the government to encourage the flow of long-term pension investments into the capital markets, like it is in many developed countries. Over time, the relative attractiveness of the NPS may have started to help alter the typically risk-averse financial behaviour of Indians. “Retirement is a concept that is more driven to 'capital protection' as a thought process. Investing in traditional investments like NPS, PPF and EPF provides a lot of comfort as you can have an approximate projected amount. Also, these investments are considered to be safe against all the market-linked investments. These products had been the traditional choices, but we see the trend changing with investors getting inclined to investments yielding higher returns,” said Dinesh Rohira, founder and CEO of 5nance.com, a wealth planner.
Equities perform better than fixed income over long periods. “PPF and EPF will not be able to offer compounding at much higher levels than the rate of inflation. However, they remain popular with individual investors due to the safety they offer, being backed by the government. NPS, an initiative by the government, is market-linked and hence not comparable to PPF and EPF,” said Kanawala.
Fixed income, however, cannot be excluded from the retirement kitty altogether because of the stability it provides. Asset allocation thus becomes a key element of planning for retirement. “No asset class or investment has the birthright of a high return. It’s only attractive if it’s priced right. Each asset has its own highs and lows and this covariance of returns between asset classes makes construction of portfolio challenging and fruitful,” said Raja of UTI Mutual Fund. “The allocation across various asset classes certainly depends upon the risk, returns and the investment horizon. A judicious mix is perhaps a portfolio skewed towards equity—say 70 to 80 per cent—when you are young and have a high 'human life value' and taper the equity down gradually as your human life value gradually reduces as you approach retirement and financial assets correspondingly increases. However, a certain modest allocation, say 10 to 20 per cent, to diversified equity is definitely required even after retirement as retirement planning is not to the retirement stage alone but through the retirement also.”
Mutual funds offer the opportunity to maintain the flow of the steady dime as well as avail the benefit of earning a lump sum at the end of a stipulated period of time. The first can be achieved by investing in monthly income plans, which are hybrid schemes that invest much of their assets in debt instruments and a small portion in equity. As for achieving the latter objective, fixed maturity plans and other closed-ended debt schemes work well. Equity mutual funds offer the much-needed opportunity for growing the size of the investment over time. Consequently, judicious asset allocation must be made to balance the two asset classes in one's portfolio. For that, a number of factors must be taken into account.
“To determine what you should invest, you should know what should be accumulated to have a comfortable retired life,” said Rohira. “Identify what amount you would require each month—in today’s value—to have a comfortable lifestyle post retirement. Consider all the incomes, like pension, annuity and rent you expect to receive post retirement and provision for the medical contingency fund. Factor in the rise in cost of living throughout the life stages. Identify all the major planned expenses post your retirement. It is equally important to consider the life expectancy of your spouse and the dependence of income by other family members. Your plan should include the estate corpus that you would wish to gift your family as well while planning for retirement.”
A few fund houses have also come up with schemes aimed specifically at investing for retirement. Some of these allow you to invest a bulk of your corpus in equities at the time of buying the scheme and progressively reduce the share of equity in favour of debt as you grow older. This takes care of asset allocation by almost putting it on autopilot. Tax benefits under section 80C of the Income-Tax Act are also applicable to some of them. An individual or a Hindu undivided family is entitled to deduction from gross total income for investments in these funds up to Rs 1.5 lakh, along with other prescribed investments, under the section.
While tax planning is an important component of retirement planning, it must not end up scuttling an ideal asset allocation and risk-return profile. “Retirement plans from the fund houses are exempt up to Rs 1.5 lakh under Section 80C along with other instruments. NPS investments get additional Rs 50,000 tax benefit under Section 80CCD. However, NPS is not a completely exempted like retirement plans of fund houses. Certain amount of investment under NPS is taxable at withdrawal,” said Raja.
“Moreover, apart from tax benefits for investments under Section 80C, long-term capital gains from retirement plans of fund houses get indexation benefits which are not allowed for returns under NPS. In addition, certain portion of NPS has to be compulsorily invested in annuity plans of insurance companies and the annuities are taxable at the hands of investors at his/her marginal rate of taxation. Hence, each product has its own strength and the availability of choices is definitely beneficial for an investor to choose the product which suits his risk-returns profile, his tax status and his/her liquidity needs,” said Raja.
Apart from protecting and growing capital, those planning for retirement must ensure that they are adequately covered against risks to their life and health. This is where insurance comes in. For long, India has understood insurance to be an instrument for investment, even though its essential function is to compensate unforeseen financial shocks. Since retirement is closely associated with ageing and the risks that accompany it, no retirement plan can be complete without the insurance piece in place.
Vishakha from IndiaFirst says that there are two aspects to insurance in the context of retirement. “In case of death before retirement, a pure insurance policy for the amount of retirement fund required is recommended to ensure that your companion can still be financially provided for. Secondly, insurance can come in while creating that corpus itself. While there are options of NPS, which offers an opportunity to save and earn market-linked returns, insurance companies also offer you an option of retirement savings for the long term with capital protection and guaranteed returns.”
Said Rohira of 5nance: “Well-structured life insurance annuity plans can provide valuable financial benefits to the policy owner during lifetime and to the beneficiaries after the insured’s lifetime. It can be an effective and versatile retirement planning tool. Combining a health plan to cover all the critical illness ensures a stability in the entire portfolio constructed for retirement.”
On the whole, planning for retirement must be an ongoing process that reflects your present situation in life and the lifestyle you aspire to have. “The glide path to retirement is like a flight plan,” said Raja. “When you fly from one place to another, you determine a flight plan, the altitude at which you will fly, much fuel you need to climb and how weather may impact the flight. Based on the airplane's weight, it may take a certain amount of fuel. Then you need a certain reserve. You plan it out, but you always build in a little additional factor, in case things don't transpire as they are supposed to, because many a time they don't. Retirement and investing are like the flight plan.”