Retirement issues have changed over the years. Retirees are living longer. Travel has increased. Healthcare costs have skyrocketed. The joint family has given way to a nuclear set-up, which means the financial and psychological benefit of a buffer are no longer there.
Simultaneously, the way we plan for retirement and the investment avenues available has also undergone a transformation.
DEEPAK R KHEMANI, financial planner and author of Compounding: The 8th Wonder, has participated in the distribution of financial products since the late eighties. Having watched how retirement planning has evolved, he writes about the experience of Mohan, who is about to retire this year.
The environment then…
Way back in the late eighties and a better part of the nineties, investing in stocks or equity mutual funds wasn’t the preferred option for retirement planning, despite equity being a very smart option to achieve long-term goals.
A lot of investors had burnt their fingers (and money) by investing in the stock market during the Harshad Mehta scam (1991-92), the tech boom (1999-2000) that infamously became known as the Ketan Parekh scam.
Interest rates in those days used to be a very lucrative 12%. The Public Provident Fund (PPF) carried that rate, so did certain small savings schemes such as Monthly Income Plans (MIP), National Savings Certificate (NSC) and Kisan Vikas Patra (KVP). Bank fixed deposits also offered double digit interest rates.
While the PPF has a tenure of 15 years, the rest were of the duration of 5 to 6 years.
The individual preference…
Mohan began to plan for his retirement scheduled in the year 2000.
Being a totally risk-averse investor, he considered two safe and long-term investment options; PPF and LIC policies.
PPF always had limits as to how much could be deposited in a year. At one time it was Rs 60,000, and it increased to the current Rs 1.5 lakh per annum limit. With the PPF having an annual limit, he looked at insurance policies.
Not only were they safe, but they came with EEE benefits: Exempt at the time of investment, Exempt for the interest (PPF) and Bonus (LIC), and Exempt at maturity. Hence, no hassles of paying any income tax or long-term capital gains tax.
Interest rates in the economy in those days were high, the bonus declared by LIC was also high. Insurance plans for 20-25-30 years duration gave IRR in the range of 8-9% tax free, along with life cover.
The investment plan…
Mohan decided he would be able to save Rs 1,00,000 per annum, in a combination of an LIC Jeevan Shree policy and PPF.
LIC Jeevan Shree Plan:
- Assured a Guaranteed Addition rate of Rs 75 per thousand sum insured
- Loyalty Additions
- Final Additional Bonus on maturity.
This one broke all records for the sales of one particular insurance policy in those days, when interest rates in the economy had started falling.
Mohan took a 20-year Jeevan Shree Plan for a sum insured of Rs 5 lakh. The premium amount of Rs 40,000 was payable yearly for 12 years only and no premium payable after that. The policy matures 8 years after the premium payment stops, which is 20 years from inception.
The balance Rs 60,000 per year for the initial 12 years was invested in a PPF account, with an option to pay less if there was insufficient saving that year. After the 12-year premium payment term ended, the plan was to put the full Rs 1 lakh in the PPF account.
In effect, he saved a total of around Rs 22 lakh. He was particular to meet the target of saving that amount every year though initially in some years he contributed less to PPF, depending on his cash flows. In the last few years, he compensated by maxing out the Rs 1.50 lakh limit of PPF.
Come 2020, the maturity amount of the LIC policy was 16,00,000. The PPF account, after completing the initial 16 yearly deposits, was extended for another 5 years to coincide with the maturity of the LIC policy, which gave another Rs 44 lakh.
He received a total amount of Rs 60 lakh, tax free which works out to an IRR of 9%. In addition, he claimed the 80C benefit while making the deposit every year. He also had a life cover of Rs 5 lakh, increasing every year.
Rs 60 lakh today kept in a life-long annuity @6% will fetch him Rs 3.60 lakh a year or Rs 30,000 a month. An investment in the Pradhan Mantri Vaya Vandana Yojana (PMVYY) or Senior Citizens Savings Scheme (SCSS) @7.4% would yield Rs 4.44 lakh yearly, which is higher but still insufficient to manage monthly household expenses. This, despite Mohan being extremely frugal in his day-to-day lifestyle and manages to live with what he’s got.
This investment, unlike a lifelong annuity, comes with a reinvestment risk when the term ends, 8 years for SCSS and 10 years for PMVVY.
(All figures have been rounded off to facilitate understanding and a simpler calculation of investment and returns.)
How to mess up your retirement planning
- By not taking inflation into account. When you have a long-term savings goal such as retirement, you must account for the fact that what may sound good now, may be insufficient in two decades.
- By not respecting asset allocation. Any investment in a single asset class, even though tax free and with a reasonable IRR, is insufficient when planning goals like retirement that’s 20 to 30 years down the road. The portfolio should have a mix of different asset classes like inflation-beating equity, debt (sovereign and corporate), gold, even real estate to optimize returns over the long term.
- By blindly imitating someone else’s strategy. Do not copy someone else’s asset allocation or retirement planning strategy. What works for one may not work for another. A retired individual getting income by way of rent from their properties, or a pension, will have planned differently from someone who gets neither. Personal Finance must be Personalized.
Investment Involves Risk of Loss