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How do you plan for retirement when so many relevant questions are unanswered? You don’t know how long you will live for, but can you calculate what your expenses will be, how inflation will affect expenditure, and much else. Debashis Basu, trustee of Moneylife Foundation, presented a clear picture to the participants in a session on retirement, explaining of the various factors to be considered and the dangers of insufficient planning
Moneylife Foundation hosted the first of its two-part seminar on retirement planning on 23 March 2013. Addressing a packed audience at the Moneylife Knowledge Centre, Debashis Basu, trustee of Moneylife Foundation, discussed how to arrive at a figure that will be sufficient to last a retired life. Mr Basu began by discussing how and why it is neglected. He said, “We rarely ever bother to make the calculation, even though it is not difficult at all. One reason why it is not done is because there are competing objectives. When retirement planning is supposed to be ongoing, there are EMIs (equated monthly instalments) to pay off and the high cost of college education. Another reason is that there is much that is simply not known. Many assumptions are to be made when making a retirement plan.” Assumptions, he argued, may prove to be right or wrong, but this is no reason not to make them at all.
Mr Basu then moved on to a fictional scenario, which spanned over 40 years, to help participants understand how to formulate a plan. He said, “In this example, I have assumed everything. I have assumed that a 45-year-old man named Mr Kumar is earning Rs60,000 a month, saves Rs15,000, spends Rs20,000, has Rs20 lakh in savings and an EMI to pay off. At the same time, he is worried about his children’s higher education and wishes to travel abroad when he’s retired, two objectives competing with a much-needed retirement plan for his finances.”
If your income grows as inflation rages on, it may be possible to ignore the adverse effects of inflation. But when your income is static, it becomes a major problem. Mr Basu said, “If Mr Kumar spends Rs20,000 a month now, in 15 years, when he’s 60 and retired, he’ll be spending Rs72,000 a month. But let’s agree that his expenses drop to 80% in retirement. This means that, at 60 years, he’ll be spending Rs60,000. Have you any idea what his monthly expenses will be when he’s 85 years old? Rs480,000 a month. It’s certainly not unlikely that he will live till age of 85. In urban India, it is common. At the same time, inflation is always higher than the national figure for urban India.”
Indians do save their money, but often don’t look beyond fixed-income schemes, such as bank FDs or investment-oriented insurance products. Mr Basu said, “I have assumed that Mr Kumar has invested in recurring deposit and money-back plans. FDs give very poor post-tax returns and we’ve examined traditional insurance plans at Moneylife and found that they don’t give anything more than 6% to 7%. This is not a good rate of return. What Mr Kumar is then left with is his largest asset, which is his house. But this is an illiquid asset, which means it isn’t income-generating.”
With poor returns from investment and high inflation, how long does Mr Kumar’s retirement corpus last? Mr Basu calculated that, if Mr Kumar’s Rs20 lakh grew at 7% and he put aside Rs15,000 each month until he was 60 years, which also grew at 7%, the corpus would work out to Rs1.03 crore. If inflation then continued each year at 9%, which is likely to happen in India, Mr Kumar would run out of funds by the time he turned 77. This led to the second part of the session, when Mr Basu discussed what went wrong.
The reason why Mr Kumar’s retirement corpus was insufficient was that he did not account for the six unknowns—underinvestment risk, the risk of longevity, failure to account for sudden spikes in monthly expenses, the dominance of a non-income-generating asset real estate in the portfolios, low growth of assets and post-retirement support.
Mr Basu said, “Underinvestment risk is the danger of not having saved or invested enough for retirement, if not both. The second risk, longevity, is a big concern. The longer you live, the more likely it becomes that you will run out of money.”
The third factor, failure to account for sudden spikes in monthly expenses, is one that is completely unknowable. You cannot, for example, predict when you’ll need surgery in your later years. Mr Basu said, “We have assumed that your retirement expenses will be 80% of current expenses. But what about the month when you need surgery or are under costly medication? At this time, it could be 135% of current expenses.
The problem of overreliance on property is another problem. “Real estate works just like stock. It can go up, it can go down. In a good economic scenario, real estate appreciates, at other times it can be static. At the same time, we must remember that it many areas even in Mumbai, rental income is just 2% per annum of the property value. Your largest asset should generate a return of more than just 2%.” Mr Basu advised equity exposure as a means to achieving a sizeable corpus. Mr Basu said, “It’s difficult if you’re not the type to take risk, but you have to convince yourself. It’s the only asset class that is able to give higher returns. Of course you may have invested in mutual funds or stocks in 2008 and decided never to do so again. But you must realise its potential. Healthcare costs are rising at 20% compounded every year. A fixed deposit cannot meet this rising expense. Equity can at least try.”
Lastly, Mr Basu discussed one unknown that even he did not take into account. He said, “I haven’t included support, both monetary and non-monetary, from a son, daughter or any other family member. Indian children do support their parents, so perhaps you won’t need to bother about that big healthcare cost. I haven’t taken this into account because it’s different for different people.”
The session was followed by an engaging Q&A session, which addressed topics such as property rates, rentals and reverse mortgage. The second part of the session, the date for which will soon be announced, will focus on how best to generate this retirement corpus.