RETIREMENT PLANNING

By Prof Sameer Lakhani

INTRODUCTION
The necessities and desires in life do not cease with retirement and there will have to be a form of substitution for his current income which may allow an individual to maintain his similar standard of living. The planning which goes into substitution of this income constitutes the core of retirement planning.

Factors to be considered such as current age, retirement age, life expectancy, investment horizon, number of dependants, the dependency period, risk profile of the person, how much money will he require to cover his (and his familys) monthly expenses - areas of personal interest, medical costs, etc.
Retirement needs will have to be assessed correctly. While a short estimation will lead to the person outliving his retirement corpus which can be rather scary, a high estimation creates cash flow problems to the person during the accumulation phase. So a right balance has to be achieved. The process of approximating ones retirement needs can be done in 2 ways a) Expense Protection Method: Under this method, monthly/annual expenses of the person (just before retirement) are estimated. The figure so arrived at is adjusted for inflation rate and the concluding amount indicates the corpus required by the person upon retirement which should be able to generate regular income equal to the expenses so arrived at. b) Income Replacement Method : Here, instead of estimating retirement needs based on an individuals numerous and limitless expenses, his income just before retirement is considered. It works on the premise that a certain percentage of the income just before retirement will be sufficient for rest of the persons retired life.

1) Food & Clothing 2) Housing a) Rent; b) Property tax, property maintenance & repairs; c) Home Insurance; 3) Utilities a) Gas; b) Electricity; c) Water; d) Telephone & Mobile; e) TV bills 4) Transport 5) Insurance premium a) Medical, b) Personal Accident c) Motor 6) Income Tax 7) Liabilities a) Personal loans; b) Vehicle loans; c) Credit card payments 8) Recreation a) Travel; b) Dining out; c) Hobbies 9) Miscellaneous expenses

COMMON POST RETIREMENT EXPENSES

SOURCES OF POST RETIREMENT INCOME

1.Savings and retirement proceeds from investments; 2. Pension annuity from employer and/or insurer/mutual fund; 3. Post retirement job to supplement income e.g. Teaching, part time consultancy etc 4. Reverse Mortgage 5. Regular income from investments in form of Dividend and Interest income 6. Other sources While calculating the retirement needs estimation one should necessarily factor inflation in the working of expenses.E.g if youre planning to live on Rs 60,000 a month during retirement, a 6% inflation rate means that in 10 years you would actually need Rs 107,451 a month, and in 20 years youd need Rs 192,428 a month to cover the same expenses. In order to maintain a persons same standard of living, the return on an investment must beat or at least keep pace with the prevalent inflation rate. Sources of Retirement funds: Gratuity: Gratuity is a defined benefit plan and is one of the many retirement benefits offered by the employer to the employee upon leaving his job. An employer may offer gratuity out of his own funds or may approach a life insurer in order to purchase a group gratuity plan. In case the employer chooses a life insurer, he has to pay annual contributions as decided by the insurer. The gratuity will be paid by the insurer based upon the terms of the group gratuity scheme.

SOURCES OF POST RETIREMENT INCOME

Provident Fund: For a long time, provident fund has been the primary investment vehicle for saving for an individuals retirement nest until the entry of mutual funds and other new innovative products such as ULIP (Unit Linked Insurance Policy), ULPP (Unit Linked Pension Policy) etc. Provident fund can be considered as a debt instrument as majority of the corpus is invested in debt. How it works? A fixed sum (%) is deducted from employees salary as contribution to Provident Fund Employer also contributes his share to the Provident Fund (except Public Provident Fund)

The pooled sum is invested in various instruments, majority in debt

On maturity Employee gets his contribution + Employers contribution and interest accrued thereon on maturity and/or before maturity (due to premature withdrawal, death of the deposit holder etc.)

On death of the deposit holder before maturity In case of death of the deposit holder/employee, the sum so accumulated is paid to the legal heirs.

TYPES OF PROVIDENT FUND

ITEM STATUTORY PROVIDENT FUND (SPF) It is a provident fund (PF) set up under the provisions of the Provident Fund Act, 1925. It is maintained by the Central, state governments and their establishments. All employees of Central, State governments and government establishments. RECOGNIZED PROVIDENT FUND (RPF) A PF recognized by the Commissioner of Income Tax. The Employees PF (EPF) & Miscellaneous Provisions Act, 1952 apply for RPF. UNRECOGNIZED PROVIDENT FUND (URPF) A PF not recognized by the Commissioner of Income Tax. PUBLIC PROVIDENT FUND (PPF) A PF covered under the PPF Act, 1968.

What is it?

It covers whom?

It automatically covers any Establishment that employs > 20 persons. Establishments with < 20 employees are free/ encouraged to join RPF

NA

All individuals (whether salaried, self-employed, employed or not) and minors (through individuals acting as their guardians).

TYPES OF PROVIDENT FUND

ITEM STATUTORY PROVIDENT FUND (SPF) RECOGNIZED PROVIDENT FUND (RPF) UNRECOGNIZED PROVIDENT FUND (URPF) PUBLIC PROVIDENT FUND (PPF)

TAX BENEFITS Employees contribution Eligible for deduction under Sec 80C of Income Tax (IT) Act, 1961 Eligible for deduction under Sec 80C of Income Tax (IT) Act, 1961 Not eligible for deduction under Sec 80C of Income Tax (IT) Act, 1961. In other words, no tax exemption for employees contribution. TAXABLE AT MATURITY Not treated as income in the hands of employee in the year in which contribution is made by employer. Taxable on maturity. Eligible for deduction under Sec 80C of Income Tax (IT) Act, 1961

Employers Contribution

FULLY TAX EXEMPT FOR EMPLOYEE Not treated as income in the hands of employee in the year in which contribution is made by employer.

< 12 % of salary is tax exempt for employee.

NA- as there is no employer contribution in PPF.

>12 % of salary taxable for employee

TYPES OF PROVIDENT FUND

ITEM STATUTORY PROVIDENT FUND (SPF)
FULLY TAX EXEMPT FOR EMPLOYEE Not treated as income in the hands of employee in the year of credit. FULLY TAX EXEMPT FOR EMPLOYEE

RECOGNIZED PROVIDENT FUND (RPF)

<9.5% p.a. - is tax exempt for employee. >9.5% p.a. taxable for employee. FULLY TAX EXEMPT FOR EMPLOYEE

UNRECOGNIZED PROVIDENT FUND (URPF)

TAXABLE AT MATURITY Not treated as income in the hands of employee in the year of credit.

PUBLIC PROVIDENT FUND (PPF)

FULLY TAX EXEMPT

Interest Earned

Maturity Proceeds

Employees contribution i) Maturity amount FULLY TAX EXEMPT; ii) Interest earned TAXABLE AS Income from Other Sources. Employers contribution i) Maturity amount TAXABLE AS Salaries ii) Interest earned TAXABLE AS Profits In Lieu Of Salary.

FULLY TAX EXEMPT

SOURCES OF POST RETIREMENT INCOME

Public Provident Fund (PPF): Eligibility Individuals & Individuals on behalf of their minor. Minimum Investments Rs 500 per annum in multiples of Rs 5 and maximum Rs 1,00,000 per annum. Duration of 15 years, can be extended for one or more blocks of 5 years. Account can be discontinued but repayment of subscription along with interest will happen only after 15 years. Suitable for risk averse investors, self employed professionals, and those not covered by the EPF. Income is tax free. This Option has become even more attractive after the interest rate was benchmarked to the 10-year government bond yield. This year, the PPF will earn 8.6%, 25 basis points above the average benchmark yield in the previous fiscal. The rate will be determined by the yields of gilt securities in the secondary market. This will ensure that the PPF returns are in line with the prevailing market rates. Liquidity Moderate -You can make partial withdrawals from the sixth year onwards . But Loans are now costlier at 2% compared to 1% earlier. You must invest at least Rs500 in the PPF during a financial year or pay a penalty

SOURCES OF POST RETIREMENT INCOME

Employee Provident Fund (EPF): In any organization where 20 or more employees work at any time, is covered under the Employees Provident Fund Act ,1952. A stipulated sum ( 12% of Basic Wages + Dearness Allowances) is deducted from the salary of the employee as contribution towards the fund. The employer makes a matching contribution. The amount thus contributed is invested in government securities. the fund is managed by a board of trustees under the PF Act. The rate of Interest is fixed by the central government in consultation with the Central Board of Trustees every year during March / April. Presently it is 8.5% per year. Monthly contribution to the EPF is eligible for tax deduction under Section 80C. If a subscriber is diligent, even if he gets a modest basic salary of Rs 25,000 at 25 years , and a 10% raise every year, his EPF will make him a crorepati by the time he retires, So, dont give in to the temptation of withdrawing your PF while changing jobs. If you do this within five years of joining, not only will the withdrawn amount be taxed , even the tax benefits availed of in the previous years will be reversed Income is tax free. Liquidity is very low - You get the money only on retirement. A one-time withdrawal is allowed for certain pressing needs , such as buying or building a house, or a child marriage. Suitable for - all employees in the organized sector.

SOURCES OF POST RETIREMENT INCOME

National Savings Certificate (NSC) : Certificates are available in the denominations of Rs 1oo/-, RS 500/-, Rs 1,000/ , Rs 5,000/- and Rs 10,000.There is no maximum limit on the purchase of the certificates. Historically -Period of maturity of a certificate is six years. Certificate of Rs 100 denomination will have a maturity value of Rs 160.10. Interest accrued on the certificates every year is liable to income tax but deemed to have been reinvested. Income tax rebate is available on the amount invested and interest accruing under section 80 C. Sale to NRIs, Trusts, HUFs and AOPs is not allowed. Like the PPF, the interest on NSCs has also been Linked to the government bond yield in the secondary market. The tenure has also been shortened by a year to five years. The new 5-year NSC will offer an interest rate that is 25 basis points above the 5-year bond yield.

The government has also introduced a 10-year NSC, which will carry a coupon rate of 50 basis points above the 10-year bond yield.
Income is fully taxable at normal rate. Suitable for Risk-averse investors looking for short-term options , senior citizens and those in low tax bracket.

Liquidity Moderate - You cant withdraw before five years.

SOURCES OF POST RETIREMENT INCOME

Bank Fixed deposits: Before opening a FD one should check the rates of interest for different banks for different period. It is advisable to keep the amount in three to five small deposits instead of making one big deposits. Suitable for the taxpayers who shy from market risk, five - year FDs are the only remaining true fixed income tax-saving instrument. Even long-time favorites, such as the PPF and NSCs, have become marketlinked. Even if the 5-year benchmark bond yield moves up to 9%, NSCs will offer an interest rate of 9.25%. Banks are already offering higher rates of 9-9.5%. Senior Citizen Saving Scheme: For senior citizens, the Senior Citizens Savings Scheme has become a little attractive. It will offer an interest rate of 100 basis points above the 5-year government bond yield. But again, tax-saving FD appear a better bet because banks offer senior citizens a 25-50 basis points higher rate of interest.

Suitable for Retirees looking for a regular stream of income.NRI and HUF are not eligible to open this account.
Liquidity High - Interest paid out quarterly and premature withdrawals allowed before five years with penalty.

Interest is 9% p.a. Income is fully taxable at normal rate.Rs 15 lakh is the maximum limit per individual.

SOURCES OF POST RETIREMENT INCOME

Equity Linked Saving Scheme: (ELSS) : Tax free dividends, no tax on income, shortest lock in period , flexibility of investments and potential to give high return. All this makes ELSS funds possibly the best way to save tax. However , it may be the worst way to avail of your Section 80C limit if you tend to be reckless with investments and if notional losses give you sleepless nights . ELSS funds carry the same risk as an equity fund, so the SIP route is the best way to go about it. Liquidity is high Shortest lock in period of three years .Suitable for Investors willing to take a calculated risk. Fund Name Fidelity Tax Advantage Taurus Tax shield Canara Robecco Franklin Tax shield ICICI Pru Tax Plan Religare Tax Plan 3 years returns (%) 25.39 23.48 27.42 24.99 28.53 23.46 Value of Rs 10,000 invested on 26/12/2008 19,715 18,827 20,688 19,527 21,233 18,818

SOURCES OF POST RETIREMENT INCOME

Unit Linked Insurance Plans: (ULIP): Linked to market ,Income is tax free. Suitable for Savvy Investors who understand Switching facility as well as understand the various funds in which the Ulips can invest. Buy a Ulip only if you can continue the plan for at Least 12-15 years. Before that , the plan may not be able to recover the charges levied in the first few years. Ulip plan can be an effective asset allocation tool. Make sure your insurance plan is DTC-compliant. The DTC says that to claim tax deduction and tax exemption on maturity, an insurance plan must offer a cover of 10 times the annual premium, Buy a plan only if it meets this criterion. E.G Returns of the Ulip funds of HDFC Life as on 30 November 2011. The returns are annualized.

SOURCES OF POST RETIREMENT INCOME

Post office Small Saving Scheme: Only for resident Individual. Post Office Saving bank account. Minimum balance of Rs 250. Ceiling on a single holding is Rs 1,00,000 and joint holding is Rs 2,00,000 . Post office Time Deposits Interest rates, compounded quarterly but paid annually or at maturity. No premature closure is allowed before 6 months. No interest is paid on accounts closed before expiry of one year. Post office Monthly income Scheme Premature withdrawals are allowed after expiry of one year. Penalty at 2% of the deposit amount if withdrawals are affected on or before expiry of 3 years and 1% thereafter. Maximum limit on single account is Rs 4.5 lakhs and on joint account is Rs 9 lakhs. Instrument Saving Deposit Account 1 Year Term Deposit (T.D.) 2 Year Term Deposit (T.D.) 3 Year Term Deposit (T.D.) 5 Year Term Deposit (T.D.) 5 Year Recurring Deposit (R.D.) 5 Year Monthly Income Scheme(M.I.S) Interest Rates 4% 7.70 % 7.80 % 8.00 % 8.30 % 8.00 % 8.20 %

SOURCES OF POST RETIREMENT INCOME

Life Insurance policies: Returns are about 6 to 7 % a year. Income is tax free. Suitable for risk averse investors who dont mind low returns. Liquidity low you get money only on maturity. Traditional traditional life insurance policies are perhaps the worst way to save tax. The buyer pays a heavy price by getting returns that cannot match inflation and get an insurance cover that is too small to be of any significance. Dont buy an insurance policy only to get tax deduction and tax free income. A P PF account wilt serve this purpose better. Pension plan: Income is fully taxable at normal rate. Returns are linked to market. Liquidity low you must buy an annuity after retirement. Unit linked pension plans are sold by insurance companies. They offer greater transparency, flexibility and control to the investor. Just like a Ulip, you can tweak the asset allocation in your pension plan depending on your reading of the market and risk appetite. New Pension Scheme, which also Invest in a mix of equity, debt, and money market Instruments. The investors can choose any of the six fund houses to manage his investments. You can't buy from more than one fund house, thus limiting the choices for the investors. Pension plans are also being sold by mutual fund houses. The only thing that differentiates these plans from regular funds is the stiff penalty impose on withdrawal before the investor turn 58 years of age.

SOURCES OF POST RETIREMENT INCOME

Pension plan: Before you invest in a pension plan remember that on maturity only 33% can be withdrawn and the rest must compulsorily be used to buy an annuity. This annuity will pay the investor a monthly Income. Infrastructure Bonds: Not applicable for current assessment year. The new Section 80CCF gives you an additional tax deduction of Rs 20,000 invested in Long-term infrastructure bonds. An investment of Rs 20,000 will translate into tax savings of Rs 6180 for those in the highest 30% tax slab. Return around 9 to 9.5% a year. Income is full taxable at normal rate. Liquidity is moderate you can exit after 5 years. Suitable for investors in 20% and 30% tax brackets.

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