Adopt a balanced approach to avoid impoverishment during sunset years
According to Population Census 2011, there are nearly 104 million elderly persons (aged 60 years or above) in India and their share and size is increasing. It was 5.6 percent of the population in 1961 and increased to 8.6 percent in 2011. By 2050, the population of Indians above 65 years will increase almost three times (predicted by US-based Population Reference Bureau). The growth in elderly population is due to the longevity of life achieved because of economic well-being, better medicines and medical facilities, and reduction in fertility rates. In the urban areas, only 56 percent of male and 17 percent of female population is financially independent while the others are partially or fully dependent. Most elderly people become penurious by falling into financial trap due to their overcautious approach to investment. They do not realize that given the longevity, their retired life may extend for 30 or 40 years, which is as long a period as their working life or even more. When a retiree sees a large corpus available to him at the time of his retirement, he may tend to splurge by undertaking leisure vacations, gifting to his near and dear ones or even investing in some fraud schemes to get unrealistically higher returns. Alternately, he becomes a conservatively timid investor who deposits everything in safe and fixed income instruments that give lower returns. Our endeavour in this article is to look at the criticalities of financial planning and systematically explain adoption of a balanced approach for leading a financially stable retired life.
There are two types of retirees, viz. Pensioner and non-pensioner. While the former has regular financial backing through his pension, the latter has no such guarantee. This implies that the non-pensioner will have to start with a larger corpus to sustain his monthly expenses, while a pensioner may start his retired life with relatively smaller corpus and sustain through regular pension income. Let us assume that the current monthly expense for both is rupees one Lakh, which will rise @6% per annum due to inflation. If they both live up to the age of 90 years, then their monthly expense during their 90th year will be rupees 6.02 Lakh per month. To sustain his regulated monthly expenses through 30 years of retirement, the non-pensioner requires to start with a corpus of rupees 274.74 Lakh at the real rate of return @1.89% (annual percentage return realized on the investment of 274.74 Lakh @8% and adjusted for changes in prices due to inflation @6%). Hypothetically, if the pensioner starts his retirement with a monthly pension of rupees 0.75 Lakh, he has to cater for a monthly shortfall of 0.25 Lakh and for that, he requires a corpus of rupees 68.68 Lakh.
Given this longevity of life, a question that haunts every elderly person is as to how long will he live and how much money will he require to take care of his old age? We can broadly divide 30 to 40 years of post retirement life into 3 or 4 decades. The first decade of sixties that holds 5.3 percent of Indian population is one of reconciliation and acceptance of the retired life, and then adjusting into it. The next decade of seventies, which is of prime concern for 2.4 percent of the Indian population, is of consolidation of assets and health. Thereafter, the decade eighties is of fragile health and growing dependence on children/domestic help for 0.9 percent of Indian population, whose old-age dependency proportion has climbed from 10.9 percent in 1961 to 14.2 percent in 2011. Finally, only a miniscule percentage attain the extraordinaire decade of the nineties.
When a retiree invests, he is cautious, risk averse, and puts everything in safe income instruments; so, he will not beat the inflation. Although this is sensible and apt for capital protection, it does not help to overcome the inflationary pressures. The primary inflationary pressure is from rising medical and hospitalization costs, which is about 15 percent as compared to the average consumer price index inflation rates of 6.27 percent (average monthly of a calendar year taken over past 20 years). The real rate of return of fixed income instruments is much lower than their indicative interest rate due to the taxability of the interest earned and the inflation cost. We have exemplified this point for better understanding of the readers. Rupees one Lakh invested @ 8% gives a retiree rupees 8,000 as interest in one year. If he pays 20.8 percent tax (inclusive of 4 percent cess) on it, then interest left in hand is rupees 6,336 only, which is effectively 6.34 percent. Further, 5 percent inflation eats into this 6.34 percent interest to give a meagre 1.28 percent real rate of return. Since 1972, even gold has only given average 7.4 percent returns. Therefore, he must invest some percentage of his cash asset in the equity market, directly in stocks, if he has market experience and confidence, or through mutual funds, since they have given average return of 14.3 percent in past 10 years.
The question that arises in the mind is about the asset allocation percentage. As a guideline, he must keep 50 to 60 percent in fixed income instruments to ensure capital protection, about 20 to 30 percent in equity, 10 to 15 percent in debt mutual funds and 5 to 10 percent in gold. The elderly will do well to understand the decision dilemma created due to the risky inverse relationship between size of corpus and percentage of equity investment. If the retiree has a large corpus, then he can afford to invest a smaller percentage (up to 20 percent) in equity since his investment in other assets will take care of his financial needs. However, if his corpus is small, then he should invest a larger percentage (maximum up to 40 percent) into equity to generate better returns to meet his financial needs. Initially the retiree may invest the retirement corpus as per this guideline through systematic transfer plan (STP) in equity and lump sum in other assets.
|Asset||Diversification Percentage||Amt Invested@||Expected Returns||Real Rate of Return*||Inflation Adjusted Value after 10 Yrs||Inflation Adjusted Value in 30 Yrs|
@ Assuming the retiree has a corpus of rupees 1 Crore to invest*
Assuming CPI Inflation Rate as 6%
#Includes contingency fund (equal to six months expenses) to cater for emergencies invested in Sweep FD for better liquidity.
Thereafter, he should invest to save about 15 to 20 percent of his gross monthly income in equity mutual funds through systematic investment plan (SIP) or directly in stocks. This investment will give a fillip to his savings in his eighties or nineties as their holding period would have exceeded 15 to 20 years. To illustrate and emphasise my point: A retiree investing rupees 10,000 per month in an equity mutual fund over 20 years, generating 12 percent return, will accumulate rupees 99.91 Lakh with a growth of 76 percent in his investment of rupees 24 Lakh.
He must diversify to hedge, which is a technique designed to reduce or eliminate financial risk; for example, gold and equity will offset each other if markets change. As the time goes by, the investment returns from equity start performing better than the benchmark indices since volatility decreases and so does the probability of loss, which is only 3.7 percent after 10 years and becomes zero after 15 years. If required, the retiree must make withdrawals from his fixed income instruments. The usual dilemma is how much to withdraw in a year from the fixed income corpus. Suppose a retiree invests rupees 60 Lakh in fixed income instruments @8% return in an economic environment of 6 percent annual inflation and annually withdraws 5 percent from the corpus. Then, the value of his investment after 10 years, as per real rate of return, will reduce to rupees 43.32 Lakh. If he desires to protect his capital, then he can annually withdraw a maximum 2 percent from his corpus, to match the real rate of return @1.89%. The retiree should hold his equity investment preferably for minimum 5 years so that it can generate returns and then withdraw from it to meet financial goals or augment his sustenance income.
The retiree must also correctly comprehend the tax structure of all these assets to derive maximum advantage. Government levies tax on interest earned in most fixed income instruments, and short and long-term capital gains (STCG and LTCG) tax on equity and debt schemes at varying rates. The point to understand is that government levies tax on entire interest earned during the financial year through fixed income instruments, immaterial of the fact whether the retiree withdraws it or not for his use. However, it levies capital gains tax only on the actual gains made by the retiree during redemption or switching done in the financial year. Government adds short-term debt fund (less than 3 years) gains to the retiree’s income and taxes it at his applicable tax slab rate, whereas, it taxes long-term gains at 20 percent after the indexation benefits. This aspect and the applicable tax rates make investment in debt mutual funds more attractive than fixed income instruments. If the retiree is in the higher tax slab with income more than rupees five Lakh, then financial wisdom dictates that his debt fund investment should be more than his fixed income investment.
|Particulars||Debt Funds||Fixed Deposits|
|Amount after 3 Years||12,59,712||12,59,712|
|Effective Return Rate||8.66%||8.66%|
|Indexed Cost of Purchase||11,91,016||–|
|Gains (Taxed Amount)||68,696||2,59,712|
|Returns after tax||8.20%||5.98%|
|*LTCG Tax after indexation benefit @20% on for debt fund and Income Tax @30.9% for FD including Health and Education cess @4%|
A lot is also made of investment in property for financial security and independence. In old age, property becomes a liability due to its regular maintenance and encroachment issues. Therefore, financial prudence lies in staying cash rich and asset meagre. Feel blessed to have one residential property that the retiree occupies and invests his cash assets to provide regular cash flows. The retiree must guard against holding lot of liquid cash that he can withdraw easily or his children may coerce him to withdraw. To obviate this, he should consider making lump sum deposit in the following instruments as they restrict liquidity and give decent returns. One, Pradhan Mantri Vyaya Vandan Yojana (PMVVY) that provides an assured monthly pension of rupees 10,000/- on maximum permissible investment of rupees 15 Lakh @8% per annum for ten years, with an option to also opt for pension on a quarterly, half-yearly or annual basis. Two, Senior Citizen Savings Scheme (SCSS) that provides risk free quarterly returns @8.3% (revised on quarterly basis), on maximum permissible investment of rupees 15 Lakh for five years, which is extendable by another 3 years. Three, Government of India Savings (Taxable) Bonds, which give 7.75 percent assured returns, have 7 years tenure and no maximum investment limit. Four, Public Provident Fund (PPF) that gives 7.8 percent returns (revised on quarterly basis) on maximum permissible investment of rupees 1.5 Lakh per year for fifteen years, which is then extendable by another 5 years. All these enjoy tax benefit under sec 80C of the IT Act, but their returns are taxable as per the retiree’s applicable tax slab except PPF, which enjoys tax exemption.