Retirement Planning

What is retirement planning?

Retirement planning is the process of planning and managing your short and long-term finances to help achieve your financial dreams both during your working years and retired life. It involves analysing your financial objectives, current financial position and expected future cash flowto develop a comprehensive retirement roadmap.

Why is retirement planning required?

Without a judicious retirement plan in place you run the risk of outliving your savings and not being able to maintain the desired lifestyle in your retirement years. You also run the risk of not being able to accumulate enough corpus for your dependants owing to unfortunate and uncertain events like death, disability etc.

Retirement planning helps you determine how much to save today for retirement; how to invest your savings to get the desired returns;how to protect your assets  and provide for in case of unfortunate events and howto make judicious use of retirement income post retirement.

What are the benefits of Retirement Planning?

Retirement planning helps you maintain your desired lifestyle during old age. It helps you plan for key life stage events leading upto retirement. It provides financial security to you and your dependents by enabling you to make prudent investments during your working years. It also enables you to make the best use of your hard-earned money post retirement. One of the key benefits of effective retirement planning is to cover for any contingencies arising from uncertain events which can compromise your ability to meet your financial goals.

Is retirement planning relevant in India?

With looming demographic challenges, India faces a swelling non-working elderly population. Further, as the life expectancy of Indians increases, the number of years in retirement is also expected to increase requiring you to fund a longer retired life. Also, with the joint-family system making way for the nuclear family system, self-support during non-working years is the new world order.  Rising costs for health care and other essentials means you need to save and invest that much more and with proper planning. Therefore, a planned approach to retirement is essential.

How is retirement planning different in the Indian context?

In the Indian context retirement can only be achieved after a person has fulfilled his responsibilities towards his family (child’s education, marriage etc.). Therefore, retirement planning is not only about planning for a secured and financially independent retirement but also entails planning for key life-stage goals. It also necessitates providing protection against unforeseen events so that achieving these goals does not become a challenge.

What is the process of Retirement Planning?

Retirement planning is not an art but a definitive science which requires taking a 360 degree approach to studying one’s current financial health, long-term goals and risk appetite to design a plan that addresses the retirement and other long-term goals of an individual.

It involves a step-by-step approach:

Step 1: Identifying your financial and retirement goals

Step 2: Analysing your current financial situation

Step 3: Risk Profiling

Step 4: Asset Allocation

Step 5: Investment Allocation Strategy

Step 6: Periodic Monitoring and Rebalancing

It is essential to seek expert / professional advice and create a comprehensive roadmap based on the different stages of your life to meet your financial requirements.

How is Retirement Planning different from Financial Planning?

Financial planning is a process of setting objectives vis-à-vis your current income. It involves assessing your currents savings and assets, estimating future financial needs, and making plans to achieve monetary goals. Retirement Planning goes beyond financial planning or providing investment advice and is aimed at achieving financial security for retirement. It is aholistic solution aimed at enabling people to achieve their financial dreams both before and after retirement.

When is the right time to retire?

There is no right time for retirement. Deciding whether or not to retire is a decision that only you can take. If your financial situation, health, age and feelings about your job all point towards retirement, it’s time to call it a day. Ideally you should work as long as you can. Based on individual requirements, financial stability and liabilities, you should plan your retirement accordingly.

Why do I start early with my Retirement Planning?

It’s never too early to start. Wealth creation is a time-taking process and usually lasts throughout your lifetime. So the earlier you start the more time your money gets to multiply. By starting early with your retirement planning you can benefit from the power of compounding, manage the longevity risk and maximise your returns from high-risk and aggressive investments options. It’s always wise to start saving early.

If I start late, can I still plan my retirement?

The early bird catches the worm. Starting late with retirement planning poses many difficulties for creating a strong corpus and sufficient wealth to see you through retirement. However, the good news is that it’s never too late to start. If you are late, all is not lost and you can cover for lost ground. You can take the following measures to make up for starting late:

• Cut down expenses.
• Seek expert advice / professional help to create a roadmap for you to maximise your savings without compromising your standard of living.
• Choose investment options that give you higher returns.
• It is good to have a working spouse to generate an additional income stream.
• Look for additional income through another job / business simultaneously if possible.
• Start immediately.

Tools to Build Retirement Corpus

1. SYSTEMATIC TRANSFER PLAN

STP refers to the Systematic Transfer Plan whereby an investor is able to invest lump sum amount in a scheme and regularly transfer a fixed or variable amount into another scheme. In case of a volatile market, STP helps the investors to periodically transfer funds from one scheme (source scheme) to another (target scheme) and help them save the effort and time by compressing multiple instructions required for redemption from one scheme to invest in the other into a single instruction. Transfers are usually made from debt funds to equity funds if the market is doing well and vice versa if the market is not performing well.

The STP can be classified based on the amount transferred from the source scheme to the target scheme. If a fixed sum is transferred from the source to the target scheme, then it’s called Fixed STP, and if the sum transferred is the profit part of the investment of source scheme, then its called Capital Appreciation STP.

Advantages of STP

1. Works as SIP: You can invest in a Debt funds and from there you can start a STP to an Equity Fund , so it works like a systematic Investment Plan (SIP)
2. Works as Systemetic Withdrawal Phase: So STP can also work like SWP, because with some funds you can do transfer from Equity funds to Debt Funds, so when markets look risky to you, you can start a STP from Equity to Debt funds, which will act like SWP
3. Liquidity: Generally one does STP from Debt to Equity funds, so your money is invested in Debt fund. This means you can sell it anytime if you want. Hence it works like a Emergency Fund also. Incase you need money urgently, it can act like a liquid asset (at least for the time being in the start when you have more money in Debt fund)
4. Growth in Money: Generally one does STP from Debt to Equity funds, so your money is invested in Debt fund. This means you can sell it anytime if you want. Hence it works like a Emergency Fund also. Incase you need money urgently, it can act like a liquid asset (at least for the time being in the start when you have more money in Debt fund)

When is STP ideal

STP will make sense from DEBT to Equity when market are volatile and you dont want to take risk with your money in a short span of time, If you invest through STP in markets and markets fall or have lots of volatile moves, then this situation will be better than the one time investment option. This is still better than putting money in Bank and doing a SIP, because at least your money is earning some returns on debt part in STP

When STP does not Work

Incase markets are already at the end of a Bear market and market can start its up move anytime, in that case STP will not deliver the best returns like SIP, one time investment is a good choice in that case. But then you never know that when will markets start going up. Given that a retail investor does not have all the tools and time to research the markets, its not advisable to invest lump sum in any case. Its better to get 4-5% less returns than to see a huge downside of your money in short time, Smart investors think about returns, Smartest ones take care of risk first

Ideal for STP

Investors who want to invest lump sum money in schemes with stable returns and ensure small exposure to equity schemes in order to avail of the potential for higher growth through equities. Invest a lump sum amount in a debt-oriented scheme (Debt schemes can be either 100% debt or High Debt and Low equity). Specify a desired amount to be transferred to any equity schemes of the same AMC . This works like a SIP (Systematic Investment Plan), Lowering Risk and increasing returns. This is best suited when markets have peaked or the investor is unsure of the further uptrend in the market Search.

2. SYSTEMATIC WITHDRAWAL PLAN

While planning for retirement and selecting various tools for building this corpus one should consider two factors.

1. Inflation-adjusted monthly income at retirement.
2. Tax-free or tax-efficient monthly income at retirement.

Most people ignore the ‘distribution phase’ or the period when one relies on the most tax-efficient distribution of accumulated corpus to receive a monthly income.Your objective should be to provide for the optimum amount of income that a client can receive without having the burden of tax eating into the real return needed for his golden years. Recommending a Systematic Withdrawal Plan (SWP) is a great option for a tax-efficient monthly inflow.

An SWP option is set up in a corpus, after mentioning the amount of monthly withdrawal needed and the duration of need of the monthly withdrawal amount. Since the withdrawal is made every month/quarter, it results in the sale of a certain number of units. This would attract capital gains tax due to the withdrawal made.

Withdrawals made before one year lead to short term capital gains tax as per the tax slab for debt instruments and 15% (plus surcharge) capital gains tax on equity instruments.

An example below shows how this option can be utilised in a fund.

Let us say, on 1 Jan 2012, your client invests Rs 10,00,000 in a debt fund at an NAV of Rs 10.

The requirement is a fixed monthly income of Rs 10,000 or Rs 1,20,000 per annum. The withdrawal made per month results in the sale of some units every month.

Consider that the unit price has increased by 10% at the end of the first year (i.e., Rs 10 has moved to Rs 11 and average selling price for each withdrawal made in the year was Rs 10.50).

In the whole year, the investor would have sold 11,428 units/shares (Rs 1,20,000/10.50).

Capital gains is Rs 5,715 (0.50 per unit*11,428 units).

The capital gains tax is Rs 1,714.50 (assuming highest tax bracket of 30% minus surcharge).

Total withdrawals made were Rs 1,20,000 and tax paid is only Rs 1,714.50 for the whole year.

This rate will further drop after one year when the capital gains tax on equity falls to nil and on debt at 10% flat or 20% after indexation.

In the second illustration, let’s say the investment is Rs 10,00,000 in a debt fund at Rs 10 per unit giving the investor 1,00,000 units.

Assuming your client needs the same Rs 10,000 per month or Rs 1,20,000 per annum growing by 5% per year, and the balance corpus grows at a modest 5% per annum after withdrawals, and there is a tax of 10% on the capital gains made every year (30% in the first year), from the withdrawal of certain number of units, the corpus will last more than 27 years and the IRR is 8% post-tax!

This is a tax-efficient method of withdrawing from a corpus and providing for a balance available for estate planning also.

3. REVERSE MORTGAGE

The life expectancy in India has been rising steadily in the last few decades. However, so have the costs of medical treatment. For senior citizens, who have a lack of regular income or financial support from children, this could lead to a financial crisis. Further, gone are the days when the elderly lived with their sons and daughters, depending on them for their amenities and medical needs. The reverse mortgage, introduced by the Union Government in 2007, is an answer to such issues faced by senior citizens, giving them a life of dignity.

What is reverse mortgage?

Mr. Sharma, a central government retiree, has been living with his wife in an independent home for the last 35 years. His two sons, both settled in New York, have no intention of moving base to India. Husband and wife, well past in their sixties do not wish to live with their sons in a foreign country. Mr. Sharma, a heart patient and his wife a diabetic, have a substantial monthly medical expenditure. Not satisfied with his pension, and not wanting to depend on his sons, for household expenditure as well as medical care, he approached his bank for a solution. The bank advised him to opt for Reverse Mortgage, to ease his monthly expenses.

In simple terms, a reverse mortgage is the “opposite” of a conventional home loan. A reverse mortgage enables a senior citizen to receive a regular stream of income from a lender (a bank or a financial institution) against the mortgage of his home. The borrower (i.e. the individual pledging the property), continues to reside in the property till the end of his life and receives a periodic payment on it.

How does a reverse mortgage work?

When the home is pledged, its monetary value is arrived at by the bank, on the basis of the demand for the property, current property prices, and the condition of the house. The bank then disburses a loan amount to the borrower in the form of periodic payments, after considering a margin for interest costs and price fluctuations. The periodic payments also known as reverse EMI are received by the borrower over fixed loan tenure. With each payment, whether monthly or quarterly, the equity or the individual’s interest in the house decreases.

A reverse mortgage is an ideal option for senior citizens who require regular income, or if the property is of illiquid nature for some reason.

General guidelines for reverse mortgage

The Reserve Bank of India has formulated the following guidelines for a reverse mortgage.

Maximum loan amount would be up to 60% of the value of the residential property.

Maximum tenure of the mortgage is 15 years and minimum is 10 years. Some banks are now also offering a maximum tenure of 20 years.

Option of monthly, quarterly, annual or lump sum loan payment.

Property revaluation to be undertaken by the lender once every 5 years.

If at such time, the valuation has increased, borrowers have the option of increasing the quantum of the loan. In such a case, they are given the incremental amount in lump-sum.

Amount received through reverse mortgage is a loan and not income. Hence it will not attract any tax. However, a borrower is liable to capital gains tax, at the point of alienation of the mortgaged property by the mortgagee for the purposes of recovering the loan.

Reverse mortgage interest rates could be either fixed or floating. The rate would be determined by the prevailing market interest rates.

Eligibility Criteria for reverse mortgage

House owners above the age of 60 years. If spouse is a co-applicant, then she should be above 58 years.

Owners of a self-acquired, self-occupied residential house or flat, located in India. The titles should be clear, indicating the prospective borrower’s ownership of the property.

Property should be free from any encumbrances.

The life of the property should be of minimum 20 years.

Property should be the permanent primary residence of the individuals.

Settlement of a reverse mortgage

A reverse mortgage loan becomes due when the last surviving borrower dies, or if the borrower chooses to sell the house. The bank first gives an option to the next of kin to settle the loan along with accumulated interest, without sale of property. If the next of kin is unable to settle the loan, the bank then opts to recover the same from the sale proceeds of the property.

Any extra amount, after settlement of the loan with accrued interest and expenses, through the sale of the property, will be passed on to the legal heirs. If the sale proceeds are lower than the accrued principal plus interest amount, the loss is borne by the bank. This loss could happen in cases where the banks original estimation is not in line with the real estate market movement.

Other Highlights of reverse mortgage

Prepayment of loan: Borrowers could prepay the loan at any time during the tenor of the loan, at no prepayment penalty or charges.

Out living the tenure of the loan: If the borrower outlives the tenure of the loan, he could continue to stay in the house. The lending institution may however cease the monthly payments. Settlement of the loan is done only after the borrower’s death.

Death of one of the spouses: If one of the spouses dies, the other can still continue living in the house. Only on death of both, settlement of the loan takes place.

Foreclosure: The loan could be foreclosed by the lender if

1. The borrower has not stayed in the house for a continuous period of one year.
2. The borrower has not paid property taxes and fails to insure the home
3. If the borrower declares himself as bankrupt.
4. If the mortgaged property is donated or abandoned by the borrower.
5. If the borrower makes changes in the residential property, that could affect the security of the loan for the lender. This could be renting out part or entire house, addition of a new owner to the house’s title or creating further encumbrance on the property.
6. If the government under statutory provisions, seeks to acquire or condemn the residential property for health or safety reasons.

Drawbacks of reverse mortgage

Lengthy documentation procedures: Banks require various documents of the property. For a senior citizen this procedure could be tedious, complicated and difficult to understand.

Fixed monthly amounts: The monthly payouts are fixed. There is no provision to increase this amount in case of an emergency or contingency.

Popularity of the scheme in India

Though introduced in 2007, Reverse Mortgage has not gained much popularity in India for the following reasons.

Inadequate marketing of the product. Recent reports indicate that many of the senior citizens are not aware of the existence of such a product.

Many banks which offer Reverse Mortgage have capped the maximum loan amount available for individuals to a maximum amount of Rs. 50 lakhs to 1 crore.

Children have resentment for a reverse mortgage as they see it as giving away their family home or legacy.

Reverse Mortgage is a relatively new concept in India. It would take some time for a change in mind set of individuals to accept it. As a financial tool, Reverse Mortgage is ideal to augment a senior citizen’s income in his years ahead. Despite all its shortcomings in India, it could make good the shortfall in one’s pension or income to live a quality life ahead.

4. Fixed Deposit

Corporate Deposits are loan arrangements where a specific amount of funds is placed on deposit under the name of the account holder. The money placed on deposit earns a fixed rate of interest, according to the terms and conditions that govern the account. The actual amount of the fixed rate can be influenced by such factors at the type of currency involved in the deposit, the duration set in place for the deposit, and the location where the deposit is made

Benefits of investing in Company Fixed Deposits

• High interest.
• Short-term deposits.
• Lock-in period is only 6 months.
• No Income Tax is deducted at source if the interest income is up to Rs 5,000 in one financial year
• Investment can be spread in more than one company, so that interest from one company does not exceed Rs. 5,000

Capital Gain be saved Under Sec 54EC or Sec 54F, if the land or property sold is non-agriculture. We deal in such bonds which qualify for Sec 54EC Bonds.

• Tax can be saved under Section 54 EC by investing in bonds
• Tax can be saved under Section 54 F by investment in New residential house