Primer on Retirement Planning
What is retirement planning? How to begin estimating how much you need as corpus when you retire? Read more here
So, you probably groaned in your head when you read the title. Retirement planning is not something that you feel is something that deserves your attention because 'Hey, my career started quite recently! I have a long way to go before I start worrying about things like retirement, right?'
Wrong! Now I am not asking you to worry about it. But through this post, I will hopefully be able to teach you why you should do it whilst explaining the different options that you have out there.
According to a MetLife India Insurance survey results published in 2008(kinda old but I doubt if much has changed), over 80% Indian employees have done no retirement planning independent of any mandatory government plans. For comparison, those numbers stood at 58%, 46% and 31% for Australia, US and the UK respectively.
In India, while almost three out of four employees (71%) say they are “concerned” about outliving retirement money, only one out of every three (35%) say they have taken steps to determine retirement needs; only 20% say they have done actual planning for retirement.
Personally, I think it's a cultural thing. My brother affectionately calls his first born as 'Retirement Plan A'. Our parents/uncles/aunts did support our grandparents in some way or the other. You probably already know that it's a bit of a struggle to support our own parents. It's rather easy to extrapolate that we shouldn't expect much from our children. I mean, I consider myself to be fairly 'well brought up' but when it comes to having the discipline to be regular in sending money back home, turns out, I am a selfish douchecanoe. And if there's one thing I've learnt on reddit, it's that I am 'not the only one'.
Combine this with the fact that our country's social security is system is kinda non-existent, you and your spouse(if you're into that) are going to have to be the ones who'll have to look after yourselves. You probably have a lot of other goals that you want to plan about (like buying a house or car or preparing for your children's education, or going on a world tour, etc) but most financial planners will agree that retirment planning should be your top most priority.
Thanks to the time value of money concept, the sooner you start, the better it will be.
TL;DR:- THOU SHALL PLAN FOR RETIREMENT OR THOU SHALL REPENT!
Like all my previous posts, I am going to assume that you are not a financially savvy person and am going to try and break it down for you.
Question no.1 How can I know how much money I'll be needing post retirement?
To be honest, there's no accurate answer to that question. You'll have to make a whole lot of assumptions not only about yourself but also about the state of the economy. But the lack of accuracy shouldn't put you off from doing what you can right now. As they say in /r/running, 'When you've just started, it doesn't matter how much distance you run, you're still doing better than the millions of guys who are just sitting on their couch.'
Okay, that might have been a little too dramatic, but you get the point. Moving on.
Visualise yourself at the time of your retirement. I know it's tough but just do it. What is your average day going to look like? Resist the temptation to wonder if they've invented Star Trek style transports. A good way of doing this is to look at your retired parents and grandparents. What are their lives like? My folks spend a whole lot on groceries, medical bills and people's weddings and funerals. They travel every couple of months to visit their children or host their visits. The question is, are they spending more money than they used to when they weren't retired or are they spending less money?
More often than not, you'll find that their expenses have actually reduced since their pre-retirement era. Simply because, they don't go out partying every weekend, they no longer need to spend on their children, they no longer think that over-priced coffee is the besht, they no longer feel the need to watch movies within the first week of it's release and so on and so forth.
But then again, this differs from person to person. Some people assume that their post retirement household living expenses will only be about 70%-80% of their pre-retirement household expenses. Not a bad assumption IMO.
So, going with this assumption, suppose you currently spend about Rs. 20,000/- per month on stuff like groceries and utilities, etc, assuming you'll only need 80% of your expenses, when you retire about 30 years from now, you'll be spending about Rs. 16,000/- only, right?
Wrong again! "Accept certain inalienable truths...prices will rise, politicians will Philander, you too will get old, and when you do you'll fantasize that when you were young prices were reasonable, politicians were noble and children respected their elders." (In case you are wondering why that sounds familiar, it's from the legendary song called Sunscreen by Baz Luhrmann)
What I am trying to say is, you will have to factor in INFLATION^INFLATION^INFLATION^INFLATION. The amount of stuff you can buy for Rs.100/- today will be a lot less 30 years from now. Inflation Rate in India averaged 9.83 Percent from 2012 until 2014, reaching an all time high of 11.16 Percent in November of 2013 and a record low of 7.55 Percent in January of 2012. Ceteris Paribus, let us assume that over the next 30 years the average inflation rate is 8%, then, to maintain the same level of expenses of Rs. 20,000 per month, 30 years from now, you will need to spend about Rs. 2,00,000/- PER MONTH. (You can do the math yourself using the FV formula in MS Excel. Rate will be the expected annual inflation rate, nper will be the number of years left to your retirement, PV or present value will be your present expenses).
I am not sure what salary hikes are like in your industry/company, but for people like me who are in banking, if you are an average to above average performer, assuming you work continuously, chances are that your salary will rise in tandem with the inflation. In which case, you don't have to panic as much. People tend to shift jobs every few years and get an average hike of about 25% at every jump. This will hopefully keep your income above the inflation line. But let us assume that you are an average joe and that you won't be jumping around much. How the hell are you going to maintain your lifestyle once you are retired? Plan my friend. Plan!
You need to figure out your required retirement corpus and start building towards it. Assuming you have a life expectancy of 75 years, this corpus of yours should be able to support you for approximately 20 years past your retirement.
I hope I didn't scare you. Did I scare you? I did want to scare you but just a little bit. Relax people, there's a whole bunch of retirement planning products out there and your-friendly-neighbourhood-aspiring-financial-planner is going to break them down for you. Before we move on to that, if you want to further discuss exactly how to arrive at your retirement corpus, make posts explaining your specific scenarios. Use throwaways if you are uncomfortable with sharing your details. We'll discuss your case as a community.
Question 2: What kind of retirement planning products are out there?
In the interest of time and space, I am going to be very brief about each one of these. If you want further clarity on any of these, feel free to comment below or start a new thread. Also, I have left out the usual suspects like FDs, Mutual Funds, Insurance policies, etc.
Which of these products or a combination thereof are best suited for you is something you are going to have to figure out yourself. Preferably, in consultation with a professional. Also, make sure that you keep reviewing your choices periodically to ensure that they are in sync with your expectations.
Due to character restrictions and to facilitate future discussions, I am going to post each product as a separate comment.
P.S:- The rates and rules are as current as I could find, if you find that the information provided is incorrect/outdated, feel free to point them out.
A. PUBLIC PROVIDENT FUND (PPF)
There is a Separate Page for PPF
The PPF is a government backed, long term small savings scheme which was initially started by the Government because it wanted to provide retirement security to self employed individuals and workers in the unorganized sector.
Features:
Interest Rate (Effective April, 2020): 7.1% p.a. compounded annually
Tenure: 15 years
Maturity type?: Lumpsum
Minimum and Maximum Investment: The minimum deposit amount is Rs. 500 per annum and the upper ceiling limit is Rs. 1,50,000 per annum.
Tax Benefit?: Yes, Under Section 80C, interest is tax exempt.
NRI Friendly?: Nope. NRIs are not eligible to open an account under the Public Provident Fund Scheme. However, If you already had a PPF account, when you were resident in India, and during the tenure of the PPF account you became an NRI,then you are eligible to continue investing in the account until it matures, but on a non-repatriable basis.
Loan Facility?: Yes. You can avail a loan from your PPF account from the 3rd year of opening your account to the 6th year. Also, the loan amount will be restricted to a maximum of 25 per cent of the balance in your account at the end of the first financial year (if you opt for the loan in the third year). If you opt for a loan in the fourth year, the second year's balance will be taken in to account and so on.
Withdrawal Facility?: Customer can make one withdrawal every year, from the 7th financial year, of an amount that does not exceed 50% of the balance of the customer credit at the end of the fourth year immediately preceding the year of withdrawal or the amount at the end of the preceding year, whichever is lower.
How to?: Almost all the PSU Banks open the PPF account.
Here's an online PPF calculator
B. New Pension Scheme
New Pension System (NPS) is a defined contribution based pension system launched by Government of India with an aim to provide old-age security coverage and pension for all citizens of India. The scheme provides investors an option to avail reasonable market based returns over long term. Periodic contributions will get invested through PFRDA appointed Pension Fund Managers (PFMs) in a combination of investment avenues as per the choice of investor.
Features
It's got two tiers. Tier-I is the main pension account and is non-withdrawable. Tier-II is a voluntary savings facility which is withdrawable.
Tenure: Till you become 60 years old.
Interest Rates: Not applicable. Returns are Market based. NPS offers the investor an option to decide an asset allocation between Equity Instruments, Corporate Bonds and Government Securities, with up to 50% exposure to Equity instruments.
Maturity type?: Pension
Minimum and Maximum Investment:
Tier I: Minimum Rs. 500 per contribution and a Minimum yearly contribution of Rs. 6000/-
Tier II: Minimum Rs. 250 per contribution and a Minimum year end balance of Rs. 2000/-
Tax benefit?:
Tier I:
The contribution made by a National Pension System subscriber in Tier I scheme is deductible from the total income under Section 80CCD of the Income Tax Act. Like wise, the contribution made by the employer for the employee in Tier I of National Pension System is also deductible under Section 80CCD. However, the aggregate deduction under Section 80C, 80CCC and 80CCD is fixed at Rs.1 lakh.
So, if the NPS subscriber already has other eligible deductions such as LIC premium, PPF, bank or NSC deposits, ELSS etc., under Section 80C, 80CCC and Section 80CCD., deduction allowed under Section 80CCD in respect of National Pension System may not be of much use as the overall limit of savings eligible for deduction is pegged at Rs. 1 lakh.
Tier II: Nope.
NRI Friendly?: Yes, an NRI can open a NPS account provided he has a valid correspondence address and a bank account in India.
Loan Facility?:
Tier I: Nope.
Tier II: Nope.
Withdrawal Facility?
Tier I:
Before retirement: Maximum 20% or atleast 80% of the pension wealth to be kept invested and annuitized at retirement.
After retirement: Min 40% of the pension wealth to be kept invested in life annuity or Maximum 60% of the pension wealth may be withdrawn in lump sum or in a phased manner, between retirement age to next 10 years.
Tier II: Yes. Limitless.
How to?
Six designated Pension Fund Managers (PFMs) have been appointed who would be responsible for investing the funds and generating returns from them. An investor would have the liberty to choose or change their fund manager if so required:
• ICICI Prudential Life Insurance Company Limited
• IDFC Asset Management Asset Management Company Limited
• Kotak Mahindra Asset Management Company Limited
• Reliance Capital Asset Management Company Limited
• SBI Pension Funds Limited
• UTI Retirement Solutions Limited
Various Points of Presence have been constituted, which act as a customer interface for investors. Here's a list of PoPs where you can open the account
Here's an online NPS Calculator
C. National Savings Certificate
National Savings Certificates popularly known as NSC is a saving bond , primarily used for small saving and income tax saving investment in India, part of the Postal savings system of Indian Postal Service. The certificates were heavily promoted by the government after Independence of India in 1950s, to collect funds for "nation building".
Features
Tenure: There is a 5 year instrument(NSC VIII Issue) and there is a 10 year instrument(NSC IX Issue).
Interest rates: 8.5% for 5-year Instrument and 8.8% for 10-year Instrument. Compounded Half yearly.
Maturity type?: Lumpsum
Minimum and Maximum Investment: Minimum Rs.100/- No maximum limit available in denominations of Rs. 100/-, 500/-, 1000/-, 5000/- & 10,000/-.
Tax Benefit?: Yes. Although the Interest on NSCs is taxable, this interest is not paid to the holder but is reinvested in NSC. As this interest is re-invested in NSC which is a specified instrument u/s 8-C, a tax payer can claim this amount of interest as a tax deduction subject to maximum of Rs. 1,00,000/-.
NRI Friendly?: Nope. NRIs are not eligible to purchase these. However, if a person was a resident Indian at the time of purchasing the NSC and becomes an NRI during the maturity period, he shall be allowed to claim it's benefits..
Loan facility?: Nope. But Certificates can be kept as collateral security to get loan from banks.
Withdrawal Facility?: Yes. If certificate is encashed within one year from the date of issue, only the face value of the certificate is payable. If the certificate is encashed after completing one year but before the end of three years from the date of issuing the certificate, an amount equivalent to the face value of the certificate together with simple interest is payable.
How to?: You can apply at a post office.
Here's an online NSC maturity calculator
and here's some further reading
D. Employees Provident Fund
You are probably already in on this. Read on to understand how it works.
There are several crucial aspects about EPF that many would not know. For instance, there are two elements to EPF - EPF and Employees' Pension Scheme (EPS). The 12 per cent employee contribution goes to EPF. However, the employer's contribution is divided in 8.33 per cent that goes in EPS, subject to a maximum of Rs 541 a month. The rest goes to EPF.
Features
Interest rate: Interest rate on EPF deposits for 2013-14 is 8.75% (as announced on Jan 13, 2014). The compound interest is provided only on EPF part. The EPS part (8.33% out of 12% contribution from your employer) does not get any interest.
Tenure: You contribute till you retire and then get the pension. An employee is eligible to earn pension only on attaining 58 years of age, after completing 10 years of service. Or, on having contributed to it for 20 years. In either case, the pensionable service or number of years of contribution are increased by two years. For instance, one has attained 58 years and contributed for 25 years. Then, the pensionable service will be taken as 27 years. Or, if contributed for 20 years, then also it will be considered as 27 years.
Maturity type?: Lumpsum/Pension
Minimum and Maximum Investment: You can always invest more than 12% of your basic salary in EPF which is called VPF. In this case the excess amount will be invested in EPF and you will keep on getting the interest, but the employer is not supposed to match your contribution. He will just invest upto maximum of 12% of your basic, not more than that.
Tax Benefit?: Yes. The employer contribution is exempt from tax, while an employee’s contribution is taxable but eligible for deduction under Section 80C of Income tax Act. The money which you initially invest in EPF, the interest you earn and, finally the money you withdraw after a specified period (5 years), are all exempt from income tax. Withdrawal from an EPF amount is subject to tax if it is carried out within 5 years of employment with the same employer. However, if you have not worked for at least five years with the same employer but the EPF has been transferred to the new employer, it is not taxed.
NRI Friendly?: Nope. It is applicable to employees working in India for Indian firms wonly.
Loan facility?: Nope. But you can withdraw.
Withdrawal facility?: Yes. But only in the following conditions:
Marriage or education of self, children or siblings
Medical treatment for Self or family (spouse, children, dependent parents)
Repay a housing loan for a house in the name of self, spouse or owned jointly.
Alterations/repairs to an existing home for house in the name of self, spouse or jointly.
Construction or purchase of house or flat/site or plot for self or spouse or joint ownership
These are all subject to various unique conditions each.
How to?: Well, your HR will take care of that.
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