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Money Money Money: Top things to keep in mind while preparing retirement plan

Money Money Money: Top things to keep in mind while preparing retirement plan

By CNBC-TV18 Dec 5, 2018 8:58:54 AM IST (Published)

It's not easy to estimate how much corpus one will need after the retirement because so many factors such as lifestyle, investment options, long-term plans and most importantly inflation comes into play. But no matter how intimidating it may sound, retirement planning has become a need for working professionals, who have no income avenues after 60s.

To help you get retirement-ready, CNBC-TV18 spoke to Feroze Azeez, deputy CEO of Anand Rathi Private Wealth Management. Here's the full transcript of the interview:
Q: This is something that we do not want to really think about but the fact is that the numbers keep compounding and some of the formulas out there are pretty scary. I have seen estimates ranging from you should retire with Rs 8 crore, Rs 10 crore, to Rs 12 crore. So you are always wondering whether this is a little overblown or whether there is truth to these numbers. What is the first thing you tell your clients when they come to you to talk about retirement planning?
A: Firstly, not too many people proactively come to talk about retirement planning. So that is a subject which requires an external catalyst to start thinking like you are doing here, viewers need to be pushed to think of it.
Point two, when they come to you, you would tell them that you have to be keeping inflation in mind. Inflation is a silent killer. It has actually destroyed 98 percent of the value in the last 30 years. So if you needed Rs 2 now, you need Rs 100 or more to buy the same commodity in the last 30 years. So inflation cannot be ignored for long terms goals.
Third is, retirement will require huge attention because there is nothing called retirement loan. You get an education loan, you get every loan, but there is nothing called retirement loan. So we make sure that the person is conscious about inflation, also is conscious about placing a lot of emphasis and his allocation of the disposable income into a retirement corpus.
Q: So the question is first of all defining this corpus, how much do you need, some of the simple formulas that one looks at simply go on adding the inflation factor to your expenses as of today. So if I were to add inflation and look at the same expenses let us say 20-30 years down the line, then where would I be or how much would I need, how do you go about working the numbers?
A: One assumption, like you said, is if I have to retain my lifestyle. Forget about lifestyle upgrades which most humans actually upgrade their lifestyles. Let us assume that upgradation of lifestyle is aside, if I have an expense today of Rs 1 lakh a month, I will have to first see how far away from retirement am I.
So one variable is what is my current expense, the second variable is how far from retirement am I as an individual, and third is what is the rate of inflation you can envisage for the next 20- 25 years depending on how long do you have to work. So that is a very tough one, but you can definitely take a cue from the last 20 years history and derive at a stable number of 7-8 percent kind of an inflation number. Of course there could be in pockets of 25 years something like hyperinflation or inflation can go lower as well.
So three variables, how much do you spend today, how much time do you have, and what is the inflation rate. If you these three variables clearly written down, a simple Microsoft excel sheet can help you envisage or calculate what is the value you will need per annum to retain the same lifestyle.
Q: Assume that your monthly expense today is Rs 1 lakh which is not unthinkable in a city like Mumbai and Delhi with rent and all the other expenses involved. That means today annually your expenditure is about Rs 12 lakh. Assuming 8 percent inflation and you let that compound, the annual expense that today is Rs 12 lakh, in 25 years of time, by the time let us say a 35 year old touches 60, that annual expense is going to be Rs 82 lakh. Then if I do a simple multiplication, let us say I am 60, my annual expense is Rs 82 lakh multiplied by 20 assuming that I am going to live till 80, Rs 16 crore. Tell me there is something wrong with the math, tell me this is not the kind of money that we need or does it sound correct to you?
A: It is correct. You will get to Rs 82 lakh of requirement in the next 25 years. Of course it is mind boggling to say my Rs 12 lakh per annum expense would shoot up to Rs 82 lakh in the next 25 years. However, if you go back in time and try and see whether it has happened or not, today you said Rs 1 lakh, 25 years back the same household would be easily managing at Rs 15,000-17,000 which is exactly the same multiple.
7 times in 25 years your expense will go up at least 6-7 times in the next 25 years. Seems very difficult to comprehend at this stage, but so was it very difficult for us to comprehend 25 years back when you were spending Rs 15,000 that there would be a day I would be spending Rs 1 lakh.
Q: How do you start investing for retirement? While all of us have scattered mutual funds and we are doing ELSS and there is some saving, some long term, some medium term, short term, dedicated retirement planning and retirement savings, how do we even begin?
A: There is one good news to that Rs 16 crore number. Just like inflation compounds, your return also compounds. So at the end of 60 years, you will still need only Rs 4 crore, not the entire Rs 16 crore because you are going to use that money over a period of 20 years.
Q: So that is where the power of equities is going to come in?
A: Correct. So how does one go about once they know that this is the kind of money I will need? Then you will have to work backwards and see what is the monthly investment I will need to do. Unless your investments are going to grow greater than 8 percent, you will need the entire corpus accumulated from your salary.
If your inflation is 8 percent and growth rate of your retirement corpus is 8 percent, then you will have to put all the Rs 4 crore from your own salary. Unless your portfolio is compounding at 13-14 percent, then you know your portfolio is overtaking inflation and making a burden lesser on my actual income which is coming from daily life today.
Q: I also want to understand the concept of retirement plans because you see the glossy advertisements all around and then you wonder I have not invested, am I missing out on something? Am I doing something wrong? Just your thoughts to some of these products and whether in addition to the EPFO, in addition to the NPS, whether this is also something that should be in my basket?
A: It should be in your basket from understanding perspective. Every product might have some merits, now whether the merits over weigh the demerits is the primary question. Annuities and pension plans are either from the insurance fold or from something which is government backed or can be something which is a mutual fund. So, these are the broad categories in which I can plan my retirement.
When it comes to insurance platforms there are specific dedicated pension plans available with most insurers which relative to the rest of them are at a lower cost – setup costs are lower. Of course from an ULIP pension plan a normal pure insurance plan which is focused not on retirement will have a significantly more cost – almost twice or thrice. So, pension plans also known as retirement plans are lower on cost. Retirement plans are several which can be categorised as two, one is where I continuously fund it and then wait for a period and then it funds me back, that is an annuity which I accumulate the money and then wait for a period and that starts reciprocating and gives me back an annuity in the future.
Q: These are the deferred annuity retirement plans?
A: Yes, these are called the deferred annuity retirement plans.
The other is if I have already reached a stage of retirement and I have accumulated my corpus from elsewhere and now I want some discipline and consistency in pay-outs just like I used to get a salary then you have an immediate annuity plan where I put the money and I expect from the subsequent month a specific pre-determined pension which gets credited to my bank account. These are the two broad heads under which these products operate.
Q: Now let us talk about the accumulation stage because we are still talking about a working individual who is building that retirement corpus. The question is, mutual fund or a dedicated retirement / pension product or a mix of both? Help us understand these retirement plans even if talk about let us say ULIP oriented plan which invests primarily in the equity market, what are the merits and demerits, what are the cost structures, what kind of returns, how will I make at the end of 20-30 years?
A: One is of course return, then comes risk and then comes taxation, these are the three prime important things to evaluate and have tick marks against all of them before you invest in any product for that matter.
To make sure that you are comparing different product classes, pre-cost is the best judgement of return.
Q: That is pre-taxes?
A: Pre-tax and pre-cost. Then comes those funds in these categories which have equity investment and debt investment. Both the financial assets you can participate using a pension plan. Equity portfolios need to be compared with equity portfolios of mutual funds to do an apple and apple comparison. If I do that and if I look at the top 5 insurers and top 5 mutual funds, the mutual fund companies have beaten the equity portion of the insurance companies by about 2.8 percent.
Q: 2.8 percent in terms of the returns that they are generating?
A: Yes per annum 2.8 percent.
Q: That could be quite significant because this is money that is going to compound for 20-25 years and in every year if mutual funds are generating 2.5-3 percent more than equivalent ULIPs then that is a big gap, wouldn’t you say?
A: This analysis is a very unbiased analysis. I take all the equity assets that the top 5 fund houses manage and all the equity assets top 5 insurers manage.
Q: So, this is backdated data testing that you have already done?
A: Yes for the last 10 years and that is a long period. 2.7 percent over 10 year period is a very large compounded number. It almost becomes equal to your corpus itself which you begin with. So, on returns the retirement plans don’t score, risk I would still give it to them because they are 10 percent lower risk than an equity counterpart on the mutual fund platform and risk is also measurable. So, you use something called standard deviation to measure risk, I am not getting into technical bit, but risk is 90 percent on insurance and 100 percent on mutual funds. So, there is a 10 percent extra risk, which a mutual fund equity fund has taken to generate that 2.8 percent.
Q: This is really interesting because I thought contribution to pension plans at least that falls under your Section 80C so that is supposed to be tax exempt. So at what stage does the taxation kick in?
A: You get a tax discount when you invest of a Rs 1,50,000 per annum. So if I am investing Rs 1,50,000 per annum, that is not my only source of tax discount, but this also provides a tax discount. However, when you start getting the money, like the rest of the plans have Section 10D, which makes the entire corpus tax free, but when you take it as a recurring monthly income, that is taken as your total income and even your capital which you infuse becomes taxable.
Q: If you could give an example, if let us say am investing a certain amount in an equity ULIP vis-à-vis in a mutual fund, how will the numbers look at the end of 20-30 years?
A: If I take an example of Rs 1 lakh annual investment for 15 years period, so you have invested Rs 1 lakh for 15 years so you have accumulated Rs 15 lakhs of your capital. If it has grown at a historical rate, which has been analysed, 8 percent pre-expense, 6 percent post expense, at the end of 15 years you will have Rs 23,98,128 for your Rs 15 lakh invested at the rate of 6 percent. Then, if you gave a 20 year period for a break and then start accumulating money, at the end of 25 years you will be left with Rs 43 lakh odd. So your Rs 15 lakh became Rs 43 lakh in a pension plan and that I think has some semblance to what the past had to offer.
When you did mutual fund past analysis, if I invested Rs 1 lakh for the first 15 years and then the corpus, and I check the corpus out of curiosity at the end of 15 years, I would have had Rs 51 lakh, which supersedes the value of 25 year period on the insurance side.
Lastly, the 15 year period, if I compare the same periods and wait for the next 10 years in the mutual fund, I will be almost left with Rs 1.8 crore corpus at a 14 percent rate. This 14 percent rate has been checked whether the last 20-25 years have had this or not.
Q: The 14 percent return, is that a little aggressive to assume a near mid teen return on mutual funds?
A: I think no because when you are looking at equity with clear transparency, and I think 20-25 years, debt has no role to play in retirement to my mind. Debt has more to play with the shorter period goals. So, longer period goals should be only equity. Equity if our country is going to grow at 8 percent, if you add back inflation of 5-7 percent, 13-14 percent on the large indices over long periods is very much possible. If you have professional management, then adding the 2-3 percent extra, which of course there is going to be long term capital gains now which needs to be factored in, so if I say 14 percent, then I actually mean more than 14 percent, 15-15.5 percent. So 14 percent is doable in the next 10-15 years. Has it been more in the last 20 years? It has been more, but you cannot extrapolate just the future so you are taking something which is moderate, not the 17-18 percent returns which equities have actually delivered.
Q: You said that person who is in their 30s right now needs to retire at least with Rs 4-5 crore in order to manage retirement lifestyle. Give me some mix now between mutual fund, maybe an NPS, EPFO, whatever money is already accumulating there and I do not know if at all if you want to throw in a pension plan, what is the ideal retirement mix that you would advise in terms of investment?
A: I would use mutual funds and NPS. If I am in the accumulating phase, NPS is a very good idea. I think there the flexibility is becoming higher as time progresses. So NPS is good for accumulation phase.
Q: Why do you like the NPS and why would you club it along with mutual funds?
A: I love the NPS because it is the same fund manager at one hundred the cost. It is cumbersome of course, but I think that 1-1.5 percent saving can actually act as equal to your corpus in the next 20 years.
Q: Here is when the question comes up, should you buy an annuity as you said you can buy an annuity, give the insurance company that lump sum payment and then you will get monthly income or should you put that money in a mutual fund and do a systematic withdrawal plan (SWP), so help us out here?
A: If you are planning to buy an annuity, the first question is what tax slab are you likely to be and what are you currently in because annuity is a one-way street. You cannot reverse the decision. I can get into a mutual fund, set up a SWP, six months later, I can buy an annuity but I cannot do that vice versa. So point one I am making is you have to be very clear when you are buying an annuity that you will be in the lowest tax bracket. If you are not then annuity is certainly not even a choice because in a SWP, the taxation is only to the extent of the return on your capital. So if you have put a crore for example, which is your retirement corpus, you are expected to make Rs 7 lakhs to Rs 8 lakhs a year in a debt fund. So the tax is only on this Rs 7-8 lakhs but if I put this crore on a pension fund and then take the corpus, the entire pension is taxable.
Q: The whole Rs 1 crore that I am putting in my pension corpus.
A: When it comes back to me in parts, all of it is taxable. So it will not come back to me on a particular day but it is coming in chunks, it is not just the differential between my capital and my pay-out, which is getting taxed but the entire pension is being taxed.
So if you – point one I am trying to drive home is it is not a one-way street. So be very careful. If you are on the lowest tax bracket and it is likely that you will remain there then an annuity still brings in immense discipline. Mutual funds don’t bring in discipline and human beings are not disciplined inherently.
So I would need an external compulsion to not take back my money in lump sum so that is one big advantage of annuity. Third is when you are doing a systematic withdrawal plan, you can move depending on the macroeconomic situations very well but annuities don’t provide you that kind of flexibility to move between equity and debt.
Q: Now let us once again return and numbers, I am going to park whatever example you take, Rs one crore, Rs two crore, Rs three crore whatever I am parking my retirement corpus in annuity plan, vis-à-vis mutual fund, systematic withdrawal plan – what are the chances or where are the chances of the money lasting me longer and ensuring it covers me through my life?
A: If you are just going to buy yourself plain debt in mutual funds then it will almost last you equal on a pre-tax basis. So what I would do is, I will take my annuity, break it into two parts. One is which will survive at least 7-8 years, so I will break my retirement corpus into two portions, one let us assume, I have a crore, I will put Rs 50 lakhs in equity assuming that this Rs 50 lakh can take care of me for the next 6-7 years. So that this Rs 50 lakh, which has been kept aside as part two, which will be after I finish my first corpus has grown significantly more and last 10 years rather than 7 years.
Q: So basically both the chunks you will put it in equity or will it be one in equity and one in debt?
A: One will be in debt, the one which I am going to consume in the next six-seven years has to be in debt. In specific kind of debt funds, which can lock me 7-8 percent interest and then I am taking a systematic withdrawal plan and eating away into the first component. The second component is running faster for me and trying to create value rather than just protect me and 7-8 years, I don’t think equity will not overtake debt and give you better returns. So your retirement corpus, half of it is working far more powerfully in that other half. So the first half is stable giving me money on a monthly basis, the second half is working to make sure that it sustains me 10-12 years rather than just the seven years.
Q: Any final thoughts that you would like to leave viewers with maybe names if there are retirees watching the show right now and if they want to follow the advise that you have given in terms of parking their retirement money in certain debt funds and equity funds maybe some names, any final tips?
A: I think it is important to summarise because we have spoken a lot so keep inflation in mind, calculate how much will you need is the second takeaway you should remember, the third is there are three several types of retirement plans even if you skip the insurance based retirement plans, you haven’t missed much, use NPS and mutual funds is the next thing and then make sure that you have two different portions of your retirement corpus if you are retiring now, one big chunk and funds of course – let me give you a couple of equity funds for the second portion, which will not be touched for seven years. Take three funds, not just two, you can look at Mirae Asset India Equity Fund, Kotak Standard Multicap and HDFC Smallcap for half the corpus and for the debt funds you have to only choose accrual funds, Franklin Templeton Short-term Income Fund and ICICI Regular Savings Fund. If you did these two debt funds and started a systematic withdrawal plan, this five fund portfolio one part and the second part will last you at least three-five years more than not having in this way.
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