THIRD COMPONENT

Subject: Financial Planning

Topic: Impact of taxes and inflation on retirement planning

Group: 7

Group Members:

20/PCMA/111

20/PCMA/114

20/PCMA/119

20/PCMA/124

20/PCMA/138

20/PCMA/145
 INTRODUCTION

RETIREMENT PLANNING

Retirement planning determines retirement income goals and the actions and decisions

necessary to achieve those goals. Retirement planning includes identifying sources of
income, sizing up expenses, implementing a savings program, and managing assets and risk.
Future cash flows are estimated to gauge whether the retirement income goal will be
achieved. Retirement planning is ideally a lifelong process. Retirement planning takes into
account not only assets and income but also future expenses, liabilities, and life expectancy.

IMPORTANCE OF RETIREMENT PLANNING

Benefits of Retirement Planning

 Helps you maintain Your desired Lifestyle during Your old age
 Provides financial Security to you And your loved ones
 Covers for Unforeseen and Unplanned Ones Expenses

Once you retire, your income stops. If you don’t have any savings or
investments to fall back on, you will find it difficult to sustain. Also, if you are
accumulating a retirement corpus in a savings bank account, then inflation will
reduce its worth by the time you need it. Hence, you must identify the right
retirement plan and start investing in it to tackle inflation.

INFLATION

Since the value of money decreases with time, it shoots up our expenses every year, which
is indicated by the inflation rate. When you plan your retirement, which is 20-30 years
ahead, your monthly expenses are expected to be way higher in the future than today if we
consider this yearly inflation. Hence, to arrive at an effective estimate of your financial
requirements during retirement, you must apply an approximate inflation rate while
calculating the retirement corpus. Therefore, without considering the inflation, a retirement
savings plan cannot be effective enough to address your finances during retirement years.
While the commodities will be inevitably costlier in the future, the medical and healthcare
expenses will also be higher by the time you plan to retire. Hence, estimate the future
medical costs considering inflation and your age when you may need extra medical care
and support.

TAXATION

Selecting tax-smart accounts may help your retirement savings last longer. Diversification
isn't just for your investment portfolio. If you're actively saving for retirement, it's also a good
idea to diversify how and when your savings will be taxed. Doing so can help you
successfully navigate two unknowns in retirement:

How much of your income will be taxable? You need to consider not just your retirement
savings but also Social Security, pensions, nonretirement investments, and other potential
sources of income.

What will your tax rate be after you retire? Today's rates are relatively low by historical
standards, and it's conceivable they could rise before or during your golden years.

By Choosing the right mix of investment options and retirement accounts one can avail and
enjoy tax benefits during the retirement days. And that depends on several factors, your
current marginal tax rate, your tax rate in retirement, and how much flexibility you'd like
when making withdrawals in retirement.

BEST INVESTMENT OPTIONS FOR THE RETIRED ARE AS

FOLLOWS:

 NATIONAL PENSION SYSTEM

It is a government scheme which intends to provide social security to the working class.
Employees working in the public, government and private sectors can invest in this scheme.
Under this scheme, the employees will invest in a pension account at regular intervals. Once
they retire, they can withdraw a certain amount of the corpus while the remaining sum will be
paid out at regular intervals.

 PUBLIC PROVIDENT FUND

Public provident fund is a government savings scheme covered under section 80C of the
Income Tax Act, 1961. You can save up to Rs. 46800 a year in taxes by investing in PPF.
You can invest up to Rs 150000 a year, and these accounts come with a lock in period of 15
years. Investing a PPF is an excellent way of planning your retirement as it offers an
attractive rate of return.

 MUTUAL FUNDS

It is one of the best private schemes to plan your retirement. These are capable of offering
returns in the range of 12%to15% a year. Also when you invest with a long-term horizon, you
will unleash the power of compounding. Since retirement planning is done with a long term
horizon, you can initially aggressively in equity funds and then switch your investments to
debt funds as you near your retirement. Doing this will ensure that you have accumulate a
considerable sum on which you can fall back in your retired life.

 BANK DEPOSITS

Bank deposits are one of the traditional options to park savings and surplus funds You can
invest in recurring deposits (RDs). These accounts allow you to invest a fixed sum at regular
intervals and offer a much higher rate of returns than a regular savings bank account. If you
have a lump sum and would like to set aside the same for your retirement, then you can invest
in fixed deposits (FDs). The rate of returns offered by FDs is very attractive, and you would
accumulate a significant sum by Retirement planning should be considered seriously by every
earning individual as they can stay financially independent in their retired life. When there
are several plans available for the same, it is only wise to make use of them.
 IMPACT OF TAXES ON RETIREMENT PLANNING

ADVANTAGES

Advantages of contributing to tax-deferred retirement accounts include investing pre-tax

earnings, employer matching contributions, and consistent savings.

 Investing pre-tax earnings:.

Subject to annual limitations, contributions to retirement accounts are generally tax-

deductible. (The most noteworthy exception involves contributions to IRAs where an
individual and/or spouse are considered “active participants” in a qualified retirement plan or
equivalent, and their adjusted gross income exceeds certain thresholds.) By investing funds
on a pretax basis, more earnings are put to work immediately.

For example, if an individual wishes to invest $1,000 of one month’s pay, assuming a
marginal tax rate of 31 percent, the individual would have to earn approximately $1,449 in
order to invest $1,000 after taxes ($1,449 less taxes of $449).

 Employer matching contributions :

Many 403(b) and 401(k) plan sponsors encourage employees to save for retirement by
matching a portion of employee plan contributions. Matching contributions can significantly
enhance investment returns at no additional cost to the employee.

 Consistent savings:

By withholding a portion of each paycheck and contributing it directly to a tax-deferred

retirement account, employees can pursue long-term financial goals with consistency. In
addition, by investing regularly, employees can take advantage of dollar-cost averaging
(regularly investing the same amount in an individual stock or mutual fund.).
DISADVANTAGES

• Retirement plan contributions are subject to ordinary income tax and myriad potential
penalty taxes associated with retirement distributions.
• In addition, employees face restricted access to funds, limited investment selections,
and significant taxation upon the contributor’s death.
• Restricted access to funds. Qualified retirement plan provisions permit benefit
distributions to be made only after a “triggering event” has Occurred, such as
retirement.
• Although many plans include loan provisions, these may not always be available or
may be undesirable due to related borrowing costs.
• Limited investment selections. While some employer-sponsored plans offer
participants a wide variety of investment choices, others may offer only a handful. A
401(k) plan typically offers about five mutual funds from one fund family.
• In contrast, the taxable investment account alternatives are limited only by one’s
imagination.
• Significant taxation upon the contributor’s death. Those primarily concerned with
maximizing the transfer of wealth to succeeding generations must take the effect of
taxation on their legacy into account.
• Sizable tax-deferred retirement accounts may be reduced significantly by the Federal
and state estate, excise, and income taxes imposed at death.
 IMPACT OF INFLATION ON RETIREMENT PLANNING

ADVANTAGE

• Be Flexible to Cope with Inflation

The way people spend money during retirement changes, says McClanahan. They might
spend more on travel in their late 60s, but less as years go by. Inflation might impact some
areas of spending more than others, and retirees willing to be flexible can adjust on the fly.
Moving to an area with cheaper real estate taxes might help, for example. So could driving
less if gasoline prices spike.

• Let Social Security Help

Social Security is still a major part of most Americans’ retirement about half of retirees rely
on Social Security for more than 50% of their retirement income. It comes with a built-in cost
of living increase based on the published inflation rate, and despite much being written about
the potential drying up of the Social Security trust fund, it’s still estimated to provide at least
70% of expected benefits if or when it runs out of cash and that’s without any legislative
changes. All of that helps.

• Get Rid of Debt

For many investors, real estate tax inflation is their biggest concern. Instead, it should be debt
load. A record number of older Americans still have mortgages, credit card debt and even
student loans. This debt will be an anchor as inflation rises. And if it’s adjustable rate debt
say a mortgage that isn’t at a fixed rate any inflation could be a real disaster. That’s why
paying off debt should be top priority for anyone worried about late-in-life inflation.

• Keep Working in Retirement

What’s the best way to preserve your capital? Keep earning. Every dollar you earn in
retirement is a dollar you don’t have to withdraw. That’s why your biggest hedge against
inflation is your human capital, McClanahan notes. That doesn’t mean you have to keep the
9-to-5 that you might have been hoping to quit soon. McClanahan actually encourages clients
to find entirely new industries for this second act. The new experiences will help keep you
young. And every dollar earned is…a dollar that’s still in your retirement fund.

• Don’t Let Past Inflation Cloud Your Vision

“Inflation is an issue but may not be as big an issue as people think,” she says. “The real
reason you have inflation is not because there’s too much money. It’s because there’s too
much money chasing too few goods.”

The perceived risk of inflation is probably a bigger risk than inflation itself. Some money
managers even talk up inflation to convince clients into taking on inappropriate investments,

• Don’t Panic About Inflation—But Don’t Ignore It, Either

The U.S. economy has a long history of relatively mild inflation, averaging around 3%
annually. Even 3% over 25 years means the price of goods would roughly double during that
span. The inflation numbers a bit in an effort to keep down government expenses, like Social
Security, that are tied to the inflation rate. That’s one reason price hikes might feel worse to
you than the 1.4% CPI inflation rate published by the Bureau of Labor Statistics last year.

But there’s even a most important factor to weighing the real-life impact of higher prices. The
government’s CPI inflation rate is calculated from the prices of a generic basket of consumer
goods. But your personal inflation rate is almost certainly different. A 5% increase in the
price of milk might matter a lot less than a 5% increase in property taxes levied by your town.

• Keep a Steady Hand and Save Where You Can

McClanahan points out that “with inflation, you also get a rise in interest rates to
compensate.” That will benefit people who have cash on hand. In that kind of environment,
traditional retirement planning tools like laddering certificates of deposit (CDs), which
mature and roll over on a staggered basis, will act as a solid hedge. That’s because interest
rates on CDs, savings accounts and money market funds roughly track inflation. Consumer
savings interest rates are abysmal now, but ’70s kids remember 15% rates from that time,
when inflation was running high. That should provide some comfort.

Disadvantages in inflation of retirement planning

• Difficulty in anticipating future requirements

It so happens that the payout offered by the retirement policy doesn’t suffice the post-
retirement expenses; this problem, to some extent, is unavoidable. To avoid such problems,
regular analysis of the market conditions and fluctuations and performance of the policy
should be done.

• Limited deduction allowed

Many plans and policies only allow a limited deduction on the tax. The maximum deduction
allowed on life insurance premiums under the Income Tax Act, 1961 is Rs. 1.5 Lakh.

• Taxation on annuity

Whenever the investor receives the annuity after the retirement, it becomes taxable as of that
date.

• High risks for high returns

Many policies and plans are subject to market fluctuations and have higher risks. To receive
higher returns on the amount, people mostly opt for high-risk options whose continuity and
steadiness cannot be predicted.

• Lower returns on investment:

If you’ve been relying on public deposits like Public Provident Fund (PPF) and National
Savings Certificate (NSC) as your source of retirement funds, you need to consider the
impact of inflation on your returns. Over a period of time, declining interest rates can
considerably reduce the maturity value of such investments. Even if interest rates remain
constant, as in the case of Fixed Deposits, the lump sum you finally receive may be
considerably lower in real terms on account of rising inflation.

• Lower purchasing power:

Cyclic changes in the economy in terms of inflation and increasing interest rates may affect
your ability to manage your living expenses in a sustainable manner. Generally, from the age
to 60 to 70, you may want to travel extensively around the world. This entails costs relating
to hotels, airfare, sightseeing, medical insurance and the like. When you’re on a fixed
income, inflation can greatly limit your purchasing power and, in turn, affect lifestyle
choices.

• Difficult to estimate:

From the point of view of retirement planning, inflation is the least predictable. This makes
arriving at a suitable investment amount difficult. This introduces an element of uncertainty
into retirement planning.

However, you can safely assume that you will need a certain percentage of your current
annual income per year of retirement. This will depend on your existing liabilities such as
expenses related to your children.

How does impact of taxes and Inflation works on retirement planning ?

TAXES RETIREMENT PLANNING

The contributions of up to Rs 1.5 lakh made towards a pension plan under Section 80CCC
provide tax deductions. This includes the amount spent on buying a new pension plan or
renewing an existing one of similar nature. Both residents and non-residents may claim tax
deductions under this section. However, Hindu Undivided Families (HUFs) are not eligible to
make such claims under the given section. The withdrawals, however, are not tax-free. Only
one-third of the corpus received by the retiree (soon after reaching the retirement age)
through the pension plan is tax-free. The rest of the money is paid as an annuity and is subject
to taxation. It depends on the retiree’s income tax slab rate. There are different kinds of
pension plans which you can check below: Plans that are sponsored by an insurer where the
investment is solely in debt and are best suited for conservative investors. Plans that are unit-
linked and invest in both equity and debt. The National Pension Scheme, which invests either
100% in government securities, 100% in debt securities (other than government securities), or
a maximum of 75% in equity. There is no doubt that pension plans are a much safer form of
investment with multiple classifications based on the benefits of the plan and its structure.

INFLATION RETIREMENT PLANNING

Investment in a retirement plan can be rewarding in the future only if you plan wisely,
keeping in mind all the critical factors. Inflation is one such factor that plays a vital role in
analysing your requirements during retirement years.

The price of almost everything is bound to rise in the future.Net retirement expenditure will
always be higher than current expenditure. Therefore, it is important to consider inflation
while planning for retirement. Inflation is a quantitative measure of the rate at which the cost
of a commodity or a service rises over a given period of time.

Inflation has a huge influence on our financial lives. The federal government also uses
inflation as a benchmark when deciding to increase contribution limits to qualified retirement
plans or raise monthly Social Security benefits. Inflation impacts ability to live well during
retirement years. The primary concern for retirees is how inflation affects how they can spend
their money on important necessities such as medical and healthcare.

Energy sector stocks and REITs often grow in value alongside the inflation rate and are
smart choices for investors. Most pensions, unlike Social Security payments, don’t offer a
cost-of-living adjustment that keeps pace with the current inflation rate. State and local
government pensions typically offer up to a 2% or 3% adjustment a year. Private-sector
employers that still provide pensions, however, typically don’t offer a COLA at all. There
may be a tension between enhancing a pension’s adjustment and maintaining the plan’s
longer-term financial health.

Why is Inflation a Significant Factor While Planning retirement?

Since the value of money decreases with time, it Shoots up our expenses every year, which is
indicated By the inflation rate. If we look at India’s inflation rate For the last two years, it
was 4.76% for 2019 and 6.2% For 2020.When you plan your retirement, which is 20-30 years
Ahead, your monthly expenses are expected to be Way higher in the future than today if we
consider This yearly inflation. Hence, to arrive at an effective Estimate of your financial
requirements during Retirement, you must apply an approximate inflation Rate while
calculating the retirement corpus.

Why consider inflation before investing?

Inflation is a cause for concern among investors, especially those with less risk appetite (like
pensioners) and live on a fixed income. Increase in price will inadvertently impact interest
rates too. The effect of inflation on your investment portfolio is based on its underlying
securities. Putting your money only or mostly in equities has historically succeeded in
keeping up with the pace of inflation. This is because the company’s income and turnover
tend to rise in tandem with inflation. So, the share value also increases accordingly.

Inflation is an important parameter an investor should consider when he/she invests in any
scheme. Low-risk investments like fixed deposits and PPF give returns from 7% to 9%, while
with moderate to high-risk investments like mutual funds generate 14% to 20% returns.
Mutual funds like ELSS offer you inflation-beating earning potential. Thus, we will be able
to retain or boost your current living standards.