The 3 main challenges in retirement planning and how to overcome them

Capitalstars Investment Advisor

The real problems in retirement planning are not about corpus. If we have an aggressive saving habit and have enough income to not touch it while working, we are all likely to retire with enough wealth.

Do I have enough money to retire? This is easily the most asked question in retirement planning. When I wrote about the need to take charge of your 40s, friends asked for a method to evaluate whether they have enough. Let’s consider some pointers. How much is enough is a tough question to answer. The easier approach is to look at the current spending levels and assume that the same lifestyle has to be maintained in retirement. If someone spends Rs 50,000 a month on an average, in current rupee terms, and if we assume that such a person will live 30 years into retirement, we can use a thumb rule to ask if they have a retirement corpus of Rs 50,000 x 12 x 30, or Rs 1.8 crore.

Purists will argue we have not considered inflation. We can counter-argue we have also not considered the growth in the corpus. Since we are not going to use up the Rs 1.8 crore in one shot, but use only a part of it, we would invest the rest and thus it will appreciate it. The Rs 100 we have saved today will grow in value if it is invested.

The real problems in retirement planning are not about corpus. If we have an aggressive saving habit and have enough income to not touch it while working, we are all likely to retire with enough wealth. In this day and age when most middle-class incomes leave behind a surplus for saving, building an adequate amount of wealth to be able to retire comfortably is not a challenge.

There are three primary challenges in retirement planning. The first is whether our corpus is invested well to grow aggressively in value. The second is whether our income needs in retirement are well thought through and provided for. The third is whether the amount we draw from the corpus and the amount we keep invested is well balanced.

Consider the retirement saving challenge. Many believe that the contribution to PF is a good way to save. The best thing about PF is the employer contribution. When our saving is matched by the employer, we have more money to work for us. However, the biggest pitfall of this investment choice is that it is a long-term investment meant to appreciate in value over time, but is mistakenly invested in income assets that generate a defined return.

This mismatch of objectives has not been adequately addressed due to misconceived notions about risk and diversification. Even the NPS has not been able to popularise the simple idea that an index fund invested in equity shares of the largest listed companies would have provided a better return on investment. This shortchanging of the longterm interests of the saver is unfortunate.

While we may not able to change the PF rules, we can apply the principles of diversification to the rest of our savings. A simple index fund or ETF —a Nifty-based or Sensexbased product—is the simplest, easiest and lowest cost route to building a default retirement corpus. There is no need to select a fund, monitor it, and chase returns. Simply investing in the index is adequate to build a decent retirement corpus that leverages the power of equity to enhance its value.

Second is the question of income needs in retirement. Many of us believe our retirement will mean a more frugal lifestyle. That may not be necessary, nor should it be the objective. We may have made specific plans to keep our expenses in check. Owning a house by the time one retires is a good plan to keep rents in check.

The mix of expenses will change in retirement: you might spend more on new interests; on travel and tourism; on health and medicare; on gifts and giveaways. It is not always easy to estimate these expenses, and some of them may be unexpected. Many of us are not used to severe budgeting and planning exercises and are rightly spooked about running short. The limit to our expenses is set by the third factor in that list.

The third element in retirement planning is the much-feared drawdown. What this means is the amount of the corpus we will actually end up spending in retirement. The simplistic assumption many make is that they will invest the corpus, and live on the interest it earns. That is harmful thinking in at least three ways: One, you leave the corpus unchanged in value, investing it to generate income for a long period of 30 years. Such a long-term asset should be invested better.

View your corpus as one large pool. You draw some of it—income or growth won’t matter—and you let the rest stay invested and grow in value. Your expense as a percentage of that corpus should be a small single-digit percentage. If your corpus is Rs 1 crore and your annual expense is Rs 6 lakh, you are drawing down 6%. That is quite a large number, and you may run out of it as you age. Keep that number small, at 3-4%.

That thumb rule at the start is based on this math: When you apply that simple rule of 30 times your spend as your corpus, ensure it is available to use as we just elaborated. If that wealth is locked in your house, you save on rent but earn no income. That won’t help. Hence that 30% rule: 30% of your money in the property you have anyway bought; 30% in equity for appreciation and inflation protection; 30% in income assets for your expenses and 10% as a buffer. Most of us should do well with these rules.

These five steps will help you toward a safe, secure, and fun retirement

Capitalstars Investment Advisor

Retirement planning is a multistep process that evolves over time. To have a comfortable, secure — and fun — retirement, you need to build the financial cushion that will fund it all. The fun part is why it makes sense to pay attention to the serious and perhaps boring part: planning how you’ll get there.
Planning for retirement starts with thinking about your retirement goals and how long you have to meet them. Then you need to look at the types of retirement accounts that can help you raise the money to fund your future. As you save that money, you have to invest it to enable it to grow. The surprise last part is taxes: If you’ve got tax deductions over the years for the money you’ve contributed to your retirement accounts, a significant tax bill awaits when you start withdrawing those savings. There are ways to minimize the retirement tax hit while you save for the future — and to continue the process when that day arrives and you actually do retire.

We’ll get into all of these issues in this Retirement Planning Guide. But first, start by learning the five steps everyone should take, no matter what their age, to build a solid retirement plan.


1. Understand Your Time Horizon

Your current age and expected retirement age create the initial groundwork of an effective retirement strategy. The longer the time between today and retirement, the higher the level of risk your portfolio can withstand. If you’re young and have 30-plus years until retirement, you should have the majority of your assets in riskier investments, such as stocks. Though there will be volatility, over long time periods stocks have historically outperformed other securities, such as bonds. The key word here is “long,” meaning more than 10 years at least.


2. Determine Retirement Spending Needs

Having realistic expectations about post-retirement spending habits will help you define the required size of a retirement portfolio. Most people believe that after retirement their annual spending will amount to only 70% to 80% of what they spent previously. Such an assumption is often proved to be unrealistic, especially if the mortgage has not been paid off or if unforeseen medical expenses occur. Retirees also sometimes spend their first years splurging on travel or other bucket-list goals.


3. Calculate After-Tax Rate of Investment Returns

Once the expected time horizons and spending requirements are determined, the after-tax real rate of return must be calculated to assess the feasibility of the portfolio producing the needed income. A required rate of return in excess of 10% (before taxes) is normally an unrealistic expectation, even for long-term investing. As you age, this return threshold goes down, as low-risk retirement portfolios are largely composed of low-yielding fixed-income securities.


4. Assess Risk Tolerance vs. Investment Goals

Whether it’s you or a professional money manager who is in charge of the investment decisions, a proper portfolio allocation that balances the concerns of risk aversion and return objectives is arguably the most important step in retirement planning. How much risk are you willing to take to meet your objectives? Should some income be set aside in risk-free Treasury bonds for required expenditures?


5. Stay on Top of Estate Planning

Estate planning is another key step in a well-rounded retirement plan, and each aspect requires the expertise of different professionals, such as lawyers and accountants, in that specific field. Life insurance is also an important part of an estate plan and the retirement-planning process. Having both a proper estate plan and life insurance coverage ensures that your assets are distributed in a manner of your choosing and that your loved ones will not experience financial hardship following your death. A carefully outlined plan also aids in avoiding an expensive and often lengthy probate process.


The Bottom Line

The burden of retirement planning is falling on individuals now more than ever. Few employees can count on an employer-provided defined-benefit pension, especially in the private sector. The switch to defined-contribution plans, such as 401(k)s, also means that managing the investments becomes your responsibility, not your employer’s.

Ways To Plan Retirement in India

Capitalstars Investment Advisor

Retirement is one of the important phases of a person’s life when the person, after decades of dedicated service, finally calls it a day. This is the time that professionals look forward to, when after years of toiling and handling responsibilities, they can finally enjoy their full, family time. However, retirement also comes with its own share of financial woes and unpredictable measures. The absence of a regular monthly income means that strain is put on the existing savings and returns from investments.

The purview of retirement does not exclude self-employed persons and like their salaried counterparts, they too, are bound to feel the burden of a retired life unless they have planned their finances well in advance. Investments made earlier in life, if chosen well, can go a long way in ensuring financial freedom after retirement.  Here is a list of certain important ways in which retirement can be planned:

* Increase the volume of investment with an increase in income: Starting from the earlier phases in life, choosing an investment that yields dividends as and when required is very essential. As the career graph moves on, there comes a phase when the volume of investment can be increased. You must always invest more when there is any such increase in earnings.

* Start early: The cost of living in India is on an upward spiral and this makes us feel the pinch with each passing day. Therefore, it is important to start investing in your future as soon as you start earning. Younger the person is at the time of commencement of relegating funds towards a retirement investment, higher is the term build-up and the resulting payout at the time of investment-maturity.

* Allocate a fixed percentage of your income towards retirement corpus: Investing a fixed percentage of the income towards the main retirement corpus always helps. One must also be careful not to use any part of the corpus (i.e. the main amount) before retirement.

* Consider the inflation factor while taking a retirement plan:  Seeking to invest and build up on that investment is important. However, the fact that inflation affects the financial planning heavily must never be ignored or belittled. Inflation can make your returns take a plunge and therefore, while choosing any plan, you must make sure that you have taken the futuristic price-rise projections into your consideration.

* Invest in health-insurance and specific plans simultaneously: You may not be in the prime of your health in your sunset years and therefore, start early when it comes to building up the financial safeguard in times of emergency. This ensures that your savings and the returns from the investments made by you do not suffer due to medical contingencies.

Retirement Planning Tips in Your Mid-60s and Beyond

Capitalstars Investment Advisor

Retirement planning at any age can be challenging. Still, there are certain steps to take when you're in your mid-60s and beyond to make sure you're ready for those golden years.

* Many people choose to continue working past retirement age for extra income or to stay engaged.

* If you were born in 1960 or later, your full retirement age for Social Security benefits is 67.

* You can sign up for Medicare at age 65, whether or not you're retired.

* Required minimum distributions for traditional IRAs and 401(k)s start at age 70½.

At one time, the common age for retirement was 65, but times have changed. Even the Social Security Administration (SSA) has increased the age when full retirement benefits are available. Also, there has been a shift from defined-benefit plans to defined-contribution plans in many company-sponsored plans.

Adding to these changes is the fact that many savings programs are not producing projected returns. It's easy to see why many individuals may need to postpone retirement.

Of course, even if you are financially secure, reaching age 65 does not always mean it's time to retire. Many 65-year-olds love their jobs and want to continue working. Still, there are a few things to consider—and take care of—as part of retirement planning in your mid-60s and beyond.

Determine Your Retirement Readiness

If your employer's policy is to offer retirement at age 65, think about whether you are really ready to quit—from a psychological and a financial perspective. If not, consider whether you want to ask your employer to allow you to work a few more years, or if you'd like to be hired as a consultant.

Ideally, you will do this at least a year before you reach 65, as some employers start the retirement process early. Many employers now focus on hiring and retaining employees who are experienced and "know the business" to strengthen their intellectual banks.

Staying on as a salaried employee not only means you continue to receive a steady income, but you will also continue to receive health coverage and other benefits your employer offers. On the other hand, going the consultant route offers you more flexibility and could allow you to have more of a working retirement.

Create a Retirement Budget

Retirees who have saved up for many years can feel that reaching retirement age means it's time to enjoy the fruits of their labor. Fair enough, but the risk is that people can go overboard and spend it all in a few years.

To avoid falling into this trap, budget your expenses. Be sure to include new costs you plan to incur, such as extra travel. This will help you make a realistic determination of how easily you can afford some of those future plans.

Once you are no longer working, a budget is even more important, as your income will likely come from your savings, Social Security, and any pension plans you may have.

Decide the Best Time to Take Social Security

Social Security is usually included in an individual's financial projections for retirement. One key decision when factoring Social Security into your equation is to determine whether you will receive full or reduced benefits.

If you take Social Security benefits before you reach your full retirement age, your annual benefits will be lower than if you waited until you reached full retirement age.

If you do not need the payments when you reach full retirement age, consider waiting until age 70 to garner the maximum possible benefit. Waiting any longer will not raise what you'll receive.

“Factors that drive when it is best to take Social Security include the historical income of you and your spouse, your ages, and life expectancy," says Mark Hebner, founder and president, Index Fund Advisors, Inc., in Irvine, Calif., and author of “Index Funds: The 12-Step Recovery Program for Active Investors.” 

"Most adults who are healthy would benefit from suspending their Social Security until they reach age 70," Hebner adds. “There are online resources for investors to help them maximize their potential Social Security payout.”

To get a complete understanding of your Social Security benefits, including determining how much you are projected to receive, visit the Social Security Administration website.

Use Your Home for Income

If you live in a large place, it may be time to consider whether you should move to a smaller home that is less costly to maintain and/or to an area where the cost of living is lower. Changing residences could provide some additional funds to add to your retirement nest egg.

If you are not willing to move or sell your home but need additional income, consider whether the risks involved in a reverse mortgage are suitable for you. Under a reverse mortgage program, a lender uses the equity in your home to provide you with tax-free income.

Before applying for a reverse mortgage, be sure to ask as many questions as possible, including how much in fees you'll pay, the terms of the mortgage, and your receipt-of-payment options.

Manage Your Income During Retirement

If you need to take income from your savings to finance your retirement, take steps to ensure that you minimize taxes and maximize what you get to keep. Your unique financial profile will determine the most opportune time to use certain types of income.

From a general perspective, withdrawals from tax-deferred accounts such as traditional IRAs and employer-sponsored plans should occur during the years when your income tax rate is lower. This will help to minimize the amount of income tax you owe on those amounts.

Take Required Minimum Distributions

Of course, if you are of required minimum distribution (RMD) age, you must satisfy your RMD amounts from those accounts—regardless of your tax rate.

You have to start taking RMDs from your traditional IRAs and 401(k) plans at age 70½. If you miss an RMD, you will owe a 50% penalty on the amount you should have withdrawn. Keep in mind that Roth IRAs don't have RMDs. You can keep your money in a Roth as long as you want and pass the entire account to your beneficiaries.

The Bottom Line

You will likely read lots of advice about timing your retirement and ways to manage your income. Still, one thing to remember is that there is no one-size-fits-all solution.

Working with a financial planner and/or retirement counselor can help you design a solution tailored to your needs and income. Ideally, start planning for retirement as early as possible and don't forget to rebalance your investment portfolio as often as necessary.