Retirement planning is a complex but a very important topic, especially in today's context as our country is going through a process of economic and social transformation. Some of these changes are:-
- Shift from joint families to nuclear families
- Children are migrating to other cities for employment
- Higher inflation levels
- Increased life expectancy
- Rising cost of healthcare
These changes and probably others in the future, makes it imperative for us to plan for retirement early in our working lives. It is important that we understand the fundamental goal of retirement planning, which is to achieve financial independence in your retired years.
One of the fundamental tenets of finance is the principle of "time value of money". In simple terms, money loses value over time, thanks to the ugly nine letter word, inflation. Therefore the first step in the retirement planning process is capital needs analysis. There are several factors involved in need analysis including inflation, life expectancy, lifestyle and investment returns. You should take expert help from a financial planner to make sure that you have a robust financial plan. Once you have determined the amount of retirement corpus that you need, you can focus on building the corpus.
While there are several products available in the market for retirement, like Public Provident Fund, New Pension Scheme and pension plans offered by insurance companies, each with their own merits, mutual funds are very effective instruments for retirement planning. There are a number of benefits of retirement planning through Mutual funds Systematic Investment Plans (SIP):-
- Mutual funds are more tax efficient than some of the other products (e.g. pension plans). Long term capital gains for equity mutual funds are tax exempt. For debt funds capital gains are taxed at 10% without indexation and 20% with indexation. With high levels of inflation capital gains tax with indexation is often nil. Income from pension plans, on the other hand, are taxable
- Mutual Funds are very flexible instruments. There are no restrictions and penalties on regular SIP payments and withdrawals, unlike pension plan premiums or PPF
- For the smart investor, mutual funds offer more choices and transparency. You can select products based on your risk profile, track record, and fund objectives
Retirement planning is very long term in nature, and the investors can select diversified equity funds balanced funds or even long term debt funds, depending on their risk profile and time horizon. The critical success factors in retirement planning are (1) starting as early as possible to get the benefits of compounding, (2) investing in the right asset class and (3) staying disciplined on retirement planning
The table below shows a scenario analysis of the corpus built over various periods of time at different investment return rates, with a monthly SIP amount of Rs. 5000/-
The table above clearly illustrate the advantage of starting early. For example, in the above table if you started investing through SIP at the age of 30, you would generate a corpus of nearly Rs. 11 crore at your retirement (assuming 20% expected returns), by investing only Rs 5000/- per month. However, if you began at the age of 45, to generate the same corpus will need to invest Rs 1 lakh/- per month.
As you approach retirement, you should rebalance your portfolio mix to have a greater allocation to fixed income instruments like fixed maturity plans or monthly income plans, to protect your capital. In order to meet your monthly income needs after retirement, you can opt for Systematic Withdrawal option. It said that money cannot buy happiness. However, lack of financial security, does put a lot of stress in our personal lives. With proper planning and rigorous discipline, mutual fund SIP is a great investment option to ensure a very fulfilling retirement.