Retirement planning: Why you must start early

Srigith Sankar couldn't help but laugh when I asked him about his retirement plans.

"You must be kidding. Who is thinking retirement? It is too far away," says the 28-year-old engineer.

I am sure Srigith is not the only the only one not thinking about his retirement. For most youngsters who have decent salaries believe in living for the day – I can vouch for it from my interactions with a lot of young people who come to me for their financial planning.

I am sure all of us would want an early retirement with a nice house, fancy car and the works. But very few of you take it seriously and actually start working on it. For some it does not even feature in their future vision. Just as Srigith who had started laughing when I talked to him about retirement planning.

However, the key to retirement planning success is to start early and gain the benefit of the power of compounding.

To start with let me first explain why you should start planning for retirement at a very young age:

1. Life expectancy: As of 2007 the life expectancy at birth for males is 67 years and 71 years for females. With advancement in technology life expectancy is likely to increase. Result: You will have to fend for more number of years post retirement.

2. Medical emergencies: With age come health problems. With health problems, come medical expenditure which may make a huge dent in your income post retirement. Failure here could lead you to liquidate (sell) your assets in order to meet such expenses. Remember mediclaims do not always suffice.

3. Nuclear families: Gone are the days when people use to have an entire cricket team making a family. Today's youth prefer not more than two children. With westernisation coming in, the culture of joint family is changing. They prefer independence and stay away from their family.  Hence people have to develop a corpus to last them through their retirement without any help from family.

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4. No government sponsored pension plan: Unlike the US and UK where they have IRA and state pension respectively as social security benefit during retirement, the government of India does not provide such benefits. So again you are on your own.

5. Job hopping: With youngsters hopping jobs regularly they do not get benefit of plans like super annuity and gratuity. Both these require certain number of working years spent in the service of a particular employer.

6. Inflation: As you need to worry about it you need to account for it as well. You need to take into account inflation while calculating your retirement corpus as well as your returns.

Power of compounding and why you must start early

Let's take an example to understand it better. Say X is 28 years and wants to retire at 60. S/he has 32 years to go. If s/he starts investing Rs 1,500 per month for the next 30 years, then at the rate of 15 per cent (assuming s/he is doing a systematic investment plan in equity mutual funds) s/he will have a corpus of Rs 1.03 crore.

Where as if you don't start at an early and at 50 you decide to start investing then to have a corpus of Rs one crore you will require an investment of Rs 41,500 per month!

While this may not be possible starting your retirement planning when young is. It is not necessary to start with a bang. You can start with small amounts and increase it as your salary increases. Also, if you start early and you have time with you, you can gain advantage of high returns and maximise your investments by investing in equities or equity mutual funds.

How much would you require at retirement

Your first step in the process is to determine the amount you will require to sustain you through your retirement.

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Research shows that generally 80 to 90 per cent of a person's pre-retirement income suffices to maintain her/his current standard of living. You might argue that your standard of living is bound to go higher with increase in your income, and so will the expenditure. Hence you have to take into account increase in your annual income over the years. The components to be taken into account when calculating your retirement corpus are:

~ Your current age
~ Expected age of retirement
~ Life expectancy
~ Years after retirement
~ Current earnings
~ Expected annual growth (in percentage) in income
~ Annual income at retirement age
~ Rate of return on retirement corpus (in percentage)
~ Inflation rate (percentage)
~ Inflation adjusted rate of return/Real rate of return (in percentage)

After calculating your retirement corpus the next step would be to find the amount required to save to reach there. The components involved to derive this figure are:

~ Rate of return during accumulation stage (in percentage)
~ Existing invested corpus
~ Number of years to retirement

The motive behind listing these components is to explain that it is not merely accumulating Rs one crore for retirement. The right retirement corpus is one which helps you maintain your standard of living even after retirement.

A word of caution

~ Contribute every year to this fund; you might want to skip a year's contribution thinking that skipping a year will not make much of a difference. You might be wrong. ~ Systematic investment instills discipline and this is a key to accumulating a bigger corpus.

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~ Resist the temptation to withdraw. Say in the above example for some unseen reason you are unable to contribute after 15 years. Do not withdraw money from your retirement savings and let it grow for the next 15 years. This at the rate of 15 per cent will grow to almost Rs 81.5 lakh. Hence, do not withdraw unless in case of extreme emergency.

Mediclaim is one of the most important aspects of planning. Remember that medical expenditures are never foreseen. Mediclaim supports us in emergencies. At times it might not be enough but it definitely offers a buffer. So it is very important to check that your mediclaim premium is paid every year and it does not lapse.

Planning for your retirement is an on going process. It requires discipline, self study and time. The earlier you start the better it is as you can gain from the power of compounding as well as aim for a higher return.