The science behind saving for retirement

In preparing for the autumn of life, it is important for an individual to balance expenses and savings

Retirement planning takes place in two stages. The first stage is characterised by a strategy to build a corpus which is as large as possible. The larger the corpus, the better it will be for the retiree. So, we must keep an eye on ‘My EPS — My Enough Past Savings.’

The word ‘enough’ is highly subjective. The reason I call it subjective is because its quantum differs from person to person. It is dependent on our lifestyle. The simpler the lifestyle, the lesser will be the need for funds. Some individuals can manage their life on a few thousand rupees a month, with some needing up to a few lakhs.

The second phase of retirement is actually using the savings accumulated over the first phase. An important term to be kept in mind while planning for the second phase of retirement is ‘My PE — My Present Expenses.’

Often times, the first phase is automated. There are mandatory provident fund and other contributions towards the accumulation typically deducted from our earnings. There are tax benefits for most of them. It is the second phase that needs careful planning, strategy and implementation.

With ‘My EPS’, we can develop a three-pronged strategy.

Planning for contingencies

First and foremost, set aside funds for emergencies and contingencies. Set aside funds equivalent to 4-6 months’ expenses. If an individual is regularly preparing ‘My Budget’ (how much we, as a family, should spend under various heads of expenditure), this will be easy. From ‘My Budget’, whatever monthly expenses are mandatory, 4 to 6 times those expenses should be set aside for emergencies and contingencies. They can be called ‘My CEO’ – My Contingency & Emergency Options.’

As a practising financial planner, my general experience is because retirees don’t have ‘My Budget’ in place, they end up providing either too little for ‘My CEO’ or too much. If the amount is too little, then in case of emergencies, there could be a crisis. It may result in a rush to the ATM or frantic calls to friends and relatives.

If the amount is very large, then funds may not yield returns to their fullest potential. Either of the situations is not conducive to sustaining and enhancing wealth.

The second step is to provide for a regular income. Once again, it will depend on ‘My Budget.’ If ‘My Budget’ is in place, it will be easy to gauge our monthly requirement.

A budget is crucial

In the absence of ‘My Budget,’ families end up with a strategy which results in generating a regular income which is much more than needed.

Be careful of this situation. Receiving a larger than required amount on a regular basis leads to wastage. For instance, most regular income is taxable, be it from annuities (these are financial instruments which return an assured sum at regular intervals) and pension (regular income from an employer where an individual has worked; pension from the government is tax free) and returns from most other kinds of investments.

Individuals argue that even if we receive more than what is needed, we can invest the surplus again. This is certainly possible but why should we get into a situation where we first receive an amount, pay tax on it and then invest it again?

If our planning is proper, we will not generate any extra regular income and there will be no tax leakage. Simply do not withdraw the money from the investment; this will ensure that the money grows in a tax-efficient manner, in most instances. The third step is to ensure our money grows at a rate that is higher than the rate of inflation.

This can happen when investments are in equity and gold, directly or through mutual funds.

The crux of the second part of our retirement planning is to focus on ‘My EPS’ and ‘My PE.’ We all like to discuss the EPS and PE of various companies but unless ‘My EPS’ and ‘My PE’ are in place, everything else is more like party gossip.

Retirement is the final innings of our life. It will decide the eventual winner. If our money survives beyond us, we win. If we survive beyond that money, we lose.

(The author is a financial planner and the author of Yogic Wealth)

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