Some of our readers may be familiar with the 20 – 40 – 30 stages of life rule. We are students for the first 20 years of our life, work for the next 40 years and then lead retired lives for another 30 years. This implies that, we are working (by working I mean, earning money from our jobs) for less than 50% of the duration of our lives. The financial challenge should be obvious to many readers. Rising costs of the urban consumption basket, especially education, healthcare etc, makes this challenge even more serious.
Unlike the US and Europe, where senior citizens receive social security benefits from the state, India is not a welfare state. In the absence of sufficient retirement savings, the only fallback option available for Indian senior citizens is their family. Taking care of parents in their old age is part of our Indian culture. However, with changing social and economic dynamics, our society is moving towards nuclear family units either due to cultural factors or due to economic factors (children living in different cities or even countries). I have seen many seniors uprooting themselves from their homes to go and live with their children. Adjusting to change is always difficult; making the adjustment at an advanced age is even more difficult. From the children’s perspective, taking full financial responsibility of senior citizen parents puts a burden on their financial resources, especially in the early stages of their careers. If every citizen makes financial independence by the time they retire, a goal in life, then we will be on a path to a much more affluent society.
It is disappointing to see complacency with regards to retirement planning among so many people, who are doing reasonably well in their careers. I see this, especially, in younger people; people in their twenties and thirties. Since retirement planning is a long term goal, many young people do not show a sense of urgency that is required for this important goal. We have explained above, why retirement planning is important. Let us now try to understand with the help of an example, why planning for retirement from an early stage of our career is critical to success.
Before we delve into the example, we should discuss the objective of retirement planning. The fundamental goal of retirement planning is to achieve financial independence in your retirement years and to be able to maintain your current lifestyle after retirement. If you save a portion of your income and invest it, you should be able to accumulate your retirement corpus. If you are young, you have the advantage of saving and investing over a long period of time and therefore you will be able to accumulate a bigger corpus through the power of compounding.
Let us now walk through an example with numbers and hopefully you will understand, it is not as easy as it sounds.
Let us assume you are 30 years old. You will retire at 60. Your current income is र 10 Lakhs per year. Let us assume that, your basic salary is 50% of your gross salary (it is usually in the 40% to 50% range). You contribute 12% of your basic salary to Employee Provident Fund. Your employer makes a matching contribution. In addition, let us assume you will save another 10% of your gross income for retirement planning. If you think 10% savings rate is very conservative assumption, as per the RBI average household savings rate in India (as a percentage of gross national disposable income) is only 7.7%. Ask yourself, how much are you saving for retirement? If you are saving 20%, it is great; but some of our readers maybe saving less than 10%. For the purpose of this example, let us assume that, 10% is what you can reasonably expect to save.
Let us further assume that you get a salary increment of 10% every year. The chart below shows how much you will save till your retirement.
(Source: Mymfnow. The above chart depicts growth of your savings from Year 1 till Year 30)
If you get a return of 8% (compounded) on your savings, you will accumulate a corpus of र 8.1 Crores at retirement. It is impressive so far. Let us now see, how long this amount will last after your retirement. Here we come back to one of the key objectives of retirement planning, which is to maintain a certain lifestyle.
Let us assume you want to maintain the lifestyle you had towards the end of your working career. Assuming you get 8% pre tax returns on your retirement savings, your corpus will last 10 years at best. It does not look that impressive any more. But it is about to get worse, once we factor the ugly 9 letter word, inflation. Factor in 5% inflation and your corpus only about 7 – 8 years. Retired lives can be as long as 25 to 30 years. In this example, you are losing your financial independence, even before you reach the half way stage of your retired life.
So what is the solution? You should save more. Financial planners / advisors in the US suggest a 50 – 30 – 20 rule; 50% of your disposable income should be spent on basic expenses like food, rent / mortgage, utility, transportation etc, 30% can be spent on discretionary items and at least 20% should be saved for long term financial goals like retirement. The later you start retirement planning, the more you will have to save.
Saving more is not the only solution. Saving more, you will agree with me, is easier said than done. Inflation and taxes take out big part of our income. Home loan EMIs take out another big chunk. Children’s school fees, utility bills, maintenance / rent, salaries paid to staff (if any) etc can add up to a sizeable amount. If we have financial dependants other than, spouse and children, saving a large portion of the income is not always feasible. The comprehensive solution to retirement planning is both savings and investments. For effective retirement planning, you need to get higher returns on your savings. Therefore, apart from savings, you also need to have an investment plan. In the example discussed above, if instead of 8% returns you get 15% returns, your retirement corpus will last for around 20 years instead of 7 – 8 years.
Conclusion
Our Finance Minister, Mr. Arun Jaitley spoke about converting “India from a pension less society to a pensioned society”. The Finance Minister’s comment suggests that as a society we are considerably behind, as far as retirement planning is concerned. Running out of money during retirement years can emotionally be very stressful. The earlier you start saving, the more you can accumulate through the power of compounding. An early start is the most important aspect of retirement planning. Therefore, it is imperative that, we start our retirement planning, as early as we can in our careers.
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