Decrypt Retirement Before Becoming a Senior Citizen: National Pension Scheme, EPFO et al.

Retirement is not the end of an active life. Instead, it marks a period where you can finally enjoy an abundance of leisure, pick up on hobbies, travel, or just do things you couldn’t do before. A general increase in life expectancy and standard of living has made this phase longer and healthier. But retirement can be painful and depressing too, especially if one’s financial security is in doubt.

 

Many retirees find themselves helpless, not having saved enough. While some are forced to hold on to their jobs for longer, others are at the mercy of their children or relatives.

 

Strangely, planning for retirement is a lowly ranked financial goal for India’s working population. Not paying sufficient attention to it is a sure-shot way to chaos, especially when one is not at his/her best health. Seeds of investments planted in earlier years are the only way to reap fruits of prosperity later in life.

 

The article discusses the fundamentals of retirement planning.

Decrypting Retirement Before Becoming a Senior Citizen: National Pension Scheme, EPFO et al.

In India, the central and the state government provide retirement benefits to their employees in the form of regular pensions. On the other hand, employees of most private organizations and those working in the informal sector have no such facility. They must plan their retirement themselves. With the disintegration of the joint family, they no longer have a support system to depend on.

 

Though there are a few government schemes and regulations to help people save and accumulate a retirement corpus, in most cases they are ineffective. Take the example of tax benefits under section 80C of the Income Tax Act. People invest in financial products to avail tax exemptions. But in a haste to save taxes, they end up purchasing financial instruments which are inferior or less suitable for their needs.

 

The importance of retirement planning in early stages of life has a significant impact on accumulated value and yet people choose to neglect it. Even those who do plan timely often miss out on certain important factors such as inflation or asset allocation, thereby ending up with inadequate money. Goal-based planning is still not mainstream.

 

Let’s look at a few commonly over-looked points:

 

Starting Early

 

Individuals underestimate the power of compounding. The effect of starting early, even with a small amount can be significant. An INR 5, 000 monthly SIP in an equity mutual fund started at the age of 25 would be worth INR 7.4 crores by the time you hit 60. The same SIP if started when you are either 30 or 40 would be worth INR 3.5 crores or INR 76 lakhs respectively upon retirement (assuming 15% annual return). Likewise, an INR 5, 000 monthly investments in the Public Provident Fund (PPF) at the age of 25 could be worth INR 1.2 crores on retirement, while the same investment if done at 40 would be only worth INR 31 lakhs. The following graph presents the amount accumulated at the age of 60 by three different financial instruments if INR 5,000 monthly investment is made by individuals of different ages. 

 

The rates of returns (per annum) are taken to be 8.5%, 8.25%, and 15%, for a Recurring Deposit (RD), PPF, and Equity mutual fund respectively. The amounts are shown in INR crores.


Amount Accumulated  at Age 60 (INR Crores)

Another advantage of starting early is the ability to take greater risks in the search for better returns e.g. by investing a part of one’s portfolio into equities. Risk appetite only goes down with increasing responsibilities and health constraints.

 

Estimating the Required Amount

 

The amount of money required for a comfortable retirement should be estimated keeping in mind the rate of inflation, the desired standard of living as well as present income. You can arrive at a ballpark figure by calculating the future value of your current monthly income, as at retirement. Take this amount and calculate the present value of each monthly installment, required during the non-earning period (20 to 30 years), at the inflation-adjusted real rate of interest. Since this estimate just gives a reference point, the plan must be monitored regularly.

 

Inflation is the ultimate wealth destroyer. To put it in perspective, INR 11.4 lakhs would be equivalent to INR 1.0 crore, in today’s terms, after 30 years. If INR 50,000 is your present monthly expenditure, 30 years from now, you would require INR 4.4 lakhs per month to maintain the same standard of living. Inflation, assumed here at 7.5% per annum (roughly the long-term average for India) is the sole reason behind value erosion.

 

False notions such as expenses go down after retirement (expenses rarely go down and instead tend to increase due to higher medical expenses) or the pension should suffice has pushed many people towards financial stress when they are at their most vulnerable point. A pension is only half of one’s last drawn salary – and it cannot be sufficient to maintain one’s existing lifestyle. The remainder has to come from investments.

 

Creating a Good Plan

Decrypting Retirement Before Becoming a Senior Citizen: National Pension Scheme, EPFO et al. 

There are various financial products with different risk-return profiles available in the market. Many find themselves unable to understand these products or the associated jargon of the financial world.

 

With little time spent on research, they end up buying the wrong product or one with lower returns like ULIPS etc. For such people, an experienced financial advisor, who could help in building a sound portfolio as per the risk appetite and return expectations of their client, is a very important resource. The assistance of a financial advisor could add tremendous value to the overall portfolio as it would be managed dynamically.

 

People who are wary of the stock market must overcome their illogical fear and allocate a part of their savings towards equities. A little allocation towards stocks will help them understand the volatility of the markets and, realize that in the longer term, equity market can lead to true wealth creation. To beat inflation, a portion must be allocated to equities, especially through mutual funds.

 

Some Investment Options Available for Retirement Planning:

 

Equities & Equity Oriented Schemes: This is one asset class that has been consistent in beating inflation and creating wealth at a faster pace. Though direct equity exposure could be quite risky, investing in equity mutual funds which are professionally managed diversified portfolios can offer great long-term returns. Investors can invest in mutual funds as they please – monthly, yearly or a lump sum. However, a disciplined approach is recommended. Systematic Investment Plans or SIPs as they are popularly called form one such approach to create wealth in the long term by investing in mutual funds in an organized, continuous and periodic way. 

 

EPF/PPF: These are essentially debt instruments which provide a safety net but with a lower rate of return amounting to 8.5% per annum. EPF is for salaried people with the employer and employee contributing 12% of the basic (plus dearness). PPF is used by self-employed people to create a long-term corpus. Both EPF and PPF are tax efficient products where contributions are deductible under section 80C and, interest, as well as the principal, is accumulated tax-free. These products are good for risk-averse investors, but even for them investing entire savings in such product could lead to low accumulation at the retirement.

 

National Pension Scheme (NPS): NPS is a pension scheme regulated by the Central Government. While all Central Government employees are mandatorily covered by this scheme, it is open to all Indian citizens on a voluntary basis. Since one portion of the NPS is invested into equities, the scheme does not offer guaranteed returns. But at the same time, it can earn higher than traditional tax-saving investments like PPF. NPS has been around for a few years now and has managed to deliver an average of 8%-10% annualized returns. An additional deduction for investments of up to INR 50,000 is available for NPS under subsection 80CCD (1B). This is over and above the deduction of INR1.5 Lakh available under section 80C of Income Tax Act.

Decrypting Retirement Before Becoming a Senior Citizen: National Pension Scheme, EPFO et al.

People who are still confused should consult a professional financial adviser so that they start saving for their retirement the right way. People who are about to retire and have not planned well for their retirement should start managing their finances immediately and take help from advisers if they cannot figure out the way forward. Creating a robust plan is a start, but managing it year after year, modifying it when required is of utmost importance. Life after retirement can be a long pleasant vacation for people who have been meticulous and dedicated to achieving their retirement goal.