Forty and behind on retirement savings? Here's a catch-up plan

Step up savings rate, build equity-heavy portfolio, and automate investments

Ritu Arora (name changed on request), who works at a publishing house in Delhi, recently turned 40. A conversation with a senior citizen neighbour, who described his growing difficulty in coping with inflation and rising healthcare expenses, made her realise with a jolt that she had not begun saving for retirement, apart from the mandatory deduction through the Employees’ Provident Fund (EPF).

 

A recent survey by 1 Finance of 1,218 individuals aged 40-60 also revealed significant gaps in retirement preparedness. It found that 75.5 per cent of Indians nearing retirement do not have a detailed retirement plan. 

 

Low on priorty list 

 

Present bias often makes near-term expenses appear more urgent than retirement, which may be 20-25 years away. “Retirement falls into the category of important but not urgent goals. The benefits are visible only after a long period of time, while shorter-term goals demand immediate attention,” says Vishal Dhawan, founder and CEO, Plan Ahead Wealth Advisors.

 

Young earners also assume they will save more once their income rises. “Many salaried individuals assume future salary growth will compensate for delayed savings,” says Arvind Rao, founder, Arvind Rao and Associates.

 

Many people fail to recognise that longer life expectancy has made retirement planning more important now. “Some underestimate the impact of inflation on future expenses,” says Arnav Pandya, founder, Moneyeduschool.  

 

Delay raises savings burden

 

A person who starts saving at 25 has 35 years to build the target retirement corpus, while someone who starts at 40 has only 20 years.

 

Assume a target corpus of ₹5 crore and a 10 per cent annual return. A person who starts at 25 needs to save about ₹15,500 a month. One who starts at 40 needs to save almost ₹73,000 a month. “The required monthly saving becomes nearly five times higher when saving is delayed by 15 years due to the lost compounding benefit,” says Rao. 

 

Estimate the corpus

 

A 40-year-old should begin by calculating current annual expenses. The next step is to identify expenses that may not continue after retirement, such as children’s education and home loan equated monthly instalments (EMIs). The individual should also identify expenses that may rise after retirement, especially healthcare and leisure expenses. “A safe estimate is that post-retirement expenses will be about 80 per cent of current expenses,” says Rao.

 

The estimated annual retirement expense should then be inflated to age 60. At 6 per cent inflation over 20 years, an annual expense of ₹9.6 lakh becomes about ₹30.8 lakh at 60.

 

A common thumb rule is to target a retirement corpus equal to 30-35 times annual expenses at 60. “This estimate is only a broad thumb rule because retirement spending needs differ across families,” says Dhawan.

 

Another way to estimate the required corpus is to use the 4 per cent withdrawal rule. “This rule assumes that annual withdrawals should not exceed 4 per cent of the corpus,” says Rao.

 

If annual retirement expense at age 60 is ₹30.8 lakh, the base corpus required would be around ₹8 crore. Financial planners suggest adding a healthcare buffer. Once the required corpus is known, the investor should back-calculate the monthly saving needed to reach it.

 

Use right product mix 

A 40-year-old should invest too conservatively. Equity mutual funds should be a key investment vehicle as the portfolio still has a 20-year horizon to grow.  

 

Equity mutual funds tend to beat inflation and outperform many other asset classes over long periods. “Equity fund values can fall by 30-35 per cent during market corrections. Investors must be able to tolerate volatility,” says Rao.

 

Another product that can be used is the National Pension System (NPS). NPS offers additional tax benefit of ₹50,000. “Under the new tax regime, salaried individuals can invest up to 14 per cent of basic salary through NPS and qualify for deduction,” says Rao. It has a low fund management charge and allows equity allocation of up to 75 per cent.

 

EPF returns (8.25 per cent) are higher than that of many other fixed-income instruments.

 

“Employees with access to EPF should take full advantage of it and should not touch EPF money except in a life-or-death situation,” says Renu Maheshwari, Sebi-registered investment advisor, co-founder and principal advisor, Finscholarz Wealth Managers. But EPF is available only to salaried employees. 

 

Public Provident Fund (PPF) offers risk-free and tax-free returns. It has a 15-year lock-in, a positive feature for retirement planning. One can, however, invest only up to ₹1.5 lakh per annum in PPF.

 

Debt instruments such as PPF and EPF cannot provide the growth impetus that a 40-year-old’s corpus requires. “But they can provide stability and tax-free returns,” says Pandya.

 

Deferred annuity plans normally do not beat inflation. Also, annuity income tends to be taxable. The principal in deferred annuity plans may get locked, depending on the plan.

 

Real estate rental income can help, but the investment required tends to be very large. “Real estate rental returns are usually around 2.5–3 per cent,” says Maheshwari. Real estate also has an illiquidity problem because a property cannot be sold in small portions.

Remove low-yielding products from the retirement portfolio as far as possible. “Any product yielding less than 6 per cent is a mismatch for a 20-year retirement corpus,” says Rao.

 

Prioritise retirement

 

Late starters should not allocate all their money only to short- and medium-term goals. “Retirement should receive priority over vacations, furnishing a new house, or buying a new car,” says Maheshwari.

 

Late starters should identify all assets, investments and savings that can be tagged for retirement. They must then estimate how much these retirement-linked assets can grow to by age 60 and compare that projected value with the target corpus.

Once the gap is known, savers should create an annual savings plan. 

 

Monthly retirement saving should be regular. Investors should automate retirement investments. “Automation is important because manual saving is often postponed,” says Pandya. The retirement plan should also be protected against the risk of the earner’s death through adequate term insurance. “The term insurance should run at least until 70,” says Rao.

 

Work longer, if feasible

 

If the projected corpus appears inadequate, late starters should consider reskilling or upskilling so that they can work for longer. Consulting, part-time work and advisory roles after retirement can be considered.

“Working beyond 60 can reduce or defer withdrawals from the retirement corpus and allow it to compound for longer,” says  Maheshwari.

 

This strategy, however, may not be easy to implement. “Employment after 60 may be difficult to find in a young country with favourable demographics. Health may not permit full-time work or any work after 60,” says Dhawan. Work often brings stress, which a person may find difficult to handle after 60. 

                                                   Dos and don’ts   

• Start with even a small amount, raise savings rate gradually

• Use income growth to increase retirement savings instead of funding lifestyle inflation

• Avoid high-risk strategies such as F&O and short-term trading 

• Have adequate health insurance 

•    Plan for both spouses’ life spans