MAKE RETIREMENT AN ENTRY, NOT AN EXITPART III

R. GOPINATH

Recently our Finance Minister introduced budget 2012-2013 in the Parliament. The budget contains three parts. 1) Consolidated Fund, 2) Contingency Fund and 3) Public Accounts. This is where whole of Government’s accounts are fully explained. All the three tenses like past-tense, present-tense and future-tense of the finance are accounted in this finance statement. It is prepared very meticulously by a team of experts.

Imagine if such a big organisation like Government of India prepares a budget to guide its finances, what can happen to individuals like us if we do not budget our finances. Most of the people in the corporate board room budget their corporate finances, but seldom do it for their own life and for their families. A sense of invincibility supersedes their caution when it comes to personal life.

We also have seen that Governments (Countries) which violated the basic rules of finance have gone bankrupt. Why did they do that, they had a feeling of invincibility. While pessimism is bad, caution is good. Optimism is not being blind to contingencies and hoping it will never occur in our life. To be optimistic is getting prepared for any eventualities.

Every working person has to retire some day. Some at 60, at 70, at 80 or at 90. If God blesses us with 5 more years after that, or gives 10 years of life after that or destines another 15 years on Earth, what will be our position then? Are we getting prepared for it? 90% of todays workforce in India are not secured under any pension provisions.

In our previous issue we promised you, that we will discuss about one Mr. Prakash and his retirement planning. We also agreed we will help Mr. Prakash in drawing out an authentic plan that will ensure that he has a retirement life of his choice. So here goes the story of Mr. Prakash:

Mr. Prakash is a professional specialising in Company Law. He is 38 years of age. His wife Mrs. Sumati Prakash is a home maker. They have two daughters Ms. Aparna and Ms. Alka of age 9 and 6. He assists companies and corporate bodies with designing the structure and drafting agreements of funding and in matters of good governance. He has a small office in a commercial complex, and has seven staff members to assist him in his work. He does a brilliant job for his clients, and they seek his services repeatedly.

He earned `20L the previous year, after paying taxes and meeting out his office expenses and salaries to staff. He is expecting his earning to go up from the `20L level of the last year to about `24L this year. His monthly expenditure presently is in the range of `1.25L on himself and his family as a whole. Out of this about `50 thousand is spent of his children education, and extra curricular activities like swimming, music and dance. Approximately `75 thousand is spent on himself and his wife. This includes maintenance expenses for his flat, and expenses like electric bills, telephone bills and recreation.

Mr. Prakash is expecting to retire at the age of 55 and spend time in community service thereafter. He wants to have a self reliant retired life, without having to depend on his children for any financial assistance.

How to help Mr. Prakash to plan for a retired life of his choice?

One of the scientific ways of planning for retirement is called as “Expenses Provision Method.” As the name indicates, we assess the likely expenses post retirement and estimate the corpus required to meet that, then plan how much contribution is required from Mr. Prakash from now to build that corpus.

While estimating the future expenses, we must take into consideration the following:1) The present lifestyle which he has got accustomed to.2) The inflation rate that will escalate the cost for the same3) The Number of years (Longevity) he expects to make the provisions for.4) Provision of Lump sum amount to meet contingent expenses (like health related).

As per the data given above it is understood that Mr. Prakash is spending `75,000 per month (`6,00,000 for the whole year) for himself and his spouse. The expenses related to the children need not be included in his retirement planning, because we believe the children will settle down well in their lives and will need financial assistance from their father once their career has begun.

We have made certain assumptions to do the calculations.1) We have assumed 4% as the rate of inflation YOY.2) We have assumed an yield of 7% on the corpus as the flow of annuity with no return of

capital option.3) Mr. Prakash want the provision of annuity till his age 90.

Please take a look at the graphic depiction of his income and expenses till age 90

0

2250000

4500000

6750000

9000000

384042 4446 48 50 52 54 56 58 60 62 64 66 68 70 72 74 76 78 80 82 84 86 88 90

Chart 1

INCOME SELF&SPOUSE Ms AparnaMs Alka PROF EDU1 PROF EDU2TOTAL

Therefore we need to make provision of a corpus to meet out the expenses, highlighted in PURPLE above. `6,00,000 at age 38 escalated at 4% growth YOY will be `17,55,000 at his age 55 and `69,00,000 at his age 90 (unbelievable no?, you better believe it, numbers never lie). To provide for all these expenses at an annuity rate of 7% Mr. Prakash will require a corpus of `3,83,00,000. We can add another `17,00,000 to the corpus to be used only in case of emergency need or for some contingent expenses. In all he will require a corpus of `4,00,00,000.

Since he is planning to retire at age 55 and engage himself into community service, he will have start funding for this corpus right now. If we select a portfolio ( a mix of various investments) yielding 10% return, then he need to contribute 10% of his income till Ms. Aparna completes her education and then 25% of his income till Ms Alka completes her education and 40% of his income thereafter till retirement then he can achieve this goal of `4,00,00,000 corpus.

If for some reason he postpones his investments by two years then to achieve this goal he will have to contribute 20% more thereafter to reach his goal and if he postpones by 3 years then he has to contribute 30% more thereafter to reach his goal of retiring at the age of 55 with the minimum of his expenses taken care of.

The above is only an example of Expenses Provision Method of retirement planning. There is much more that the above illustrations in this planning, which we have not explained here, with a purpose of making this essay as simple as possible. One this is for for sure, that, to get a good plan drawn we need to avail the services of an expert. Retirement planning is not a commonsense matter, but it is a matter to be handled by an expert.