RETIREMENT PLANNING BASICS

Retirement Planning Basics

• Need for Retirement Planning: Retirement planning is crucial due to the increase in life expectancy, making it essential to sustain expenses post-retirement. It's not just about accumulating money, but also about living a life of one's choice after retirement.
• Definition of Retirement: The definition of retirement has changed over time, from being a period of inability to work to a period of relaxation, leisure, and sometimes a change in employment that can be financially rewarding.
• Phases of Retirement Planning: Retirement planning has various phases, including:
  • Preparation Stage: Includes needs such as child education, buying a house, and adequate life and health insurance.
  • Pre-Retirement Stage: Involves physical and psychological changes, familiarization with retirement regulations, and procedures.
  • Final Retirement Stage: The individual should have completed all necessary arrangements and be in a good position to decide about their life.

Key Concepts in Retirement Planning

• Financial Goals and Retirement: Retirement goals are often mixed with other financial goals, but they have unique features, such as the longest accumulation and distribution periods, requiring the largest corpus.
• Retirement Planning Process: The process involves:
  • Determining Expenses in Retirement: Calculating expenses that need to be met in retirement, including housing, living expenses, medical care, transportation, and insurance.
  • Determining Income Requirement in Retirement: Considering factors such as maintaining standard of living, expenses, and inflation rates.
  • Time Horizon: Calculating years to retirement and years in retirement to determine the cost of expenses and the periodic savings required.
  • Determining the Retirement Corpus: Calculating the corpus required to generate the income needed in retirement, considering variables such as periodic income, inflation, and rate of return.

Impact of Inflation on Retirement Planning

• Inflation Definition: A general rise in prices of goods and services over time, reducing the purchasing power of money.
• Impact on Retirement Planning: Inflation affects retirement planning by:
  • Increasing Expenses: Adjusting the value of current expenses for inflation to arrive at the cost of expenses at the time of retirement.
  • Escalating Cost of Living: Considering the increase in expenses due to inflation during the retirement years when calculating the retirement corpus.

Retirement Planning Basics (Part 2)

• Inflation Rate: The standard rate of inflation may not be appropriate to calculate the future cost of living expenses, as other expenses like health costs and travel increase at a higher rate.
• Expected Rate of Return: The corpus required to generate retirement income will be invested to earn a return, contributing to the corpus and reducing the required savings.
• Inflation-Adjusted Rate of Return: The real or effective rate of return on an investment after adjustment for inflation.

Estimating Retirement Corpus

• Methods: There are two methods to estimate income in post-retirement years:
  • Replacement Ratio Method: Assumes the standard of living remains the same as before retirement, and estimates the target income based on a percentage of pre-retirement income.
  • Expense Protection Method: Defines retirement income based on expenses in retirement, considering adjustments for inflation and changes in expenses.

Replacement Ratio Method

• Calculation: Replacement Income (Year 1) = Pre-retirement Income * Replacement Ratio, and subsequent years' income is increased by the inflation rate.
• Example: Mr. Rajeev earns Rs. 100000 per month and wants to retire at 60 with 50% of his income as post-retirement income.
• Limitations: The more years one has for retirement, the less accurate the income replacement estimate is likely to be.

Expense Protection Method

• Calculation: Estimates retirement income based on expenses in retirement, considering adjustments for inflation and changes in expenses.
• Example: Mr. Ashish earns Rs. 60000 per month and expects additional expenses of Rs. 15000 at retirement, with an inflation rate of 6%.
• Limitations: Estimating future retirement expenses can be difficult, especially for those far from retirement.

Superannuation Benefits to Employees

• Definition: A company pension plan created by an employer for the benefit of its employees.
• Types: Payment by the employer or funding through a trust.
• Approved Superannuation Funds: The employer can get tax exemption for contributions to the fund if it is approved by the Commissioner of Income Tax.

RETIREMENT PLANNING BASICS (Part 3)

• Definition of Approved Superannuation Fund: A superannuation fund that is established under an irrevocable trust in connection with a trade or undertaking carried on in India, with at least 90% of employees employed in India.
• Key Requirements for Approval:
  • The fund's sole purpose is to provide annuities for employees on retirement or incapacitation, or for their dependents.
  • The employer must contribute to the fund.
  • All benefits must be payable only in India.
• Tax Benefits for Approved Superannuation Funds:
  • Section 10(13): Payments from the fund are exempt from income tax, including payments on death, retirement, or incapacitation.
  • Section 10(25)(iii): Income received by the trustees is not included in computing the total income of the trust, allowing for tax-free accumulation of funds.
  • Section 36(iv): Employer contributions to the fund are allowed as a deduction in computing business income, subject to prescribed limits and conditions.
  • Section 80C: Employee contributions to the fund are eligible for deduction in computing taxable income, subject to a prescribed ceiling.
• Trustees' Responsibilities:
  • Holding periodic meetings to review the trust's performance and keeping records of minutes.
  • Communicating with the company and informing the employer of decisions taken.
  • Collecting contributions from the employer and investing trust money according to prescribed patterns.
  • Realizing interest earned on investments and re-investing it.
  • Ensuring pension benefits to employees or beneficiaries.
  • Deducting tax at source from annuity payments and remitting it to IT authorities.
  • Preparing and auditing annual accounts and submitting them to IT authorities.