TL;DR
Retirement planning is the process of managing your current finances to cover expenses after you stop working. Unlike other financial goals, it requires considering non-linear factors, such as inflation (accounting for both best- and worst-case scenarios and category-specific rates), longevity (planning for a longer life expectancy), and taxation (how taxes on withdrawals will fluctuate over time). It’s crucial to start planning and saving early to reduce stress, benefit from compounding, and have the flexibility to take on market risks for better returns. The shift to nuclear families in India has made this type of comprehensive planning even more critical, as many elderly parents now rely on their children for financial support.
It’s the story of most nuclear households in modern India, with a husband, wife, dependent parents, and children. With limited retirement support, many elderly parents today rely heavily on their children’s earnings for financial stability. Without employer-supported pensions or health insurance, their situation can quickly deteriorate.
But it’s a different story in joint families, where all earning members collectively share the cost of elderly care, and older people have better emotional support.
Although the dependency ratios have decreased in India, the increased adoption of nuclear family structures has heightened the need for comprehensive retirement planning.
The need for planning would become dire as the real income (income adjusted for inflation) of future generations would become less than that of their previous generation, as seen in developed economies like the United States, which would make it tough for future generations to cover the financial burden of their elderly.
What is retirement planning?
The word “retirement” originated from the French word “retirer,” which means “to withdraw” or “to retreat.” The current definition of the word we use today emerged when it entered the English language dictionary in the 1640s, which means to withdraw from one’s occupation or business.
When we add the word “planning” to retirement, it refers to how we plan our current financial situation to cover the costs associated with living after retirement. When we talk about costs, we need to consider
Regular monthly home running budgets.
- Any post-retirement high-value financial goals (much higher than monthly home running budgets), such as travel goals after retirement.
- Cost required to cover risks related to health (much higher than yearly home running budgets), such as medical costs, which might include health insurance premiums & out-of-pocket medical expenses that your health policy may not cover.
- Any pre-retirement dependent costs that are still applicable to those you have not considered as beneficiaries of your retirement plan.
- Any pre-retirement financial goals for which the goal terms have expanded in the retirement period, and you have planned for them separately.
Remember that your withdrawals from the retirement fund will depend on the outlay cycles for the above five costs. So, no generalized thumb rules popular on the internet will work for you, as the money requirement cycles are different for everybody.
Key assumptions to consider in your retirement plan:
Retirement is a very different type of financial goal compared to others. For any other goal, as the term ends, you withdraw the money and spend it. On the other hand, when it comes to retirement, the withdrawal intervals are spread over a more extended period, leading to various unforeseen external and personal factors that impact them, so there is no ideal method to calculate the amount of retirement funds one would require.
The key assumptions to consider:
- Inflation rate is a common factor that we consider for all financial goals. What is different here is that we can’t consider linear rates; instead, we should consider both the worst and best scenarios. You will require different amounts to cover yearly expenses each year during the retirement period. Another crucial factor to consider is the specific inflation rate for each expense category.
- Longevity is technically a curse for retirement plans. As the life expectancy of your generation improves, there is always a chance you will be left out of any money before you die. Living healthily can be a boon, as it allows you to have a better financial life over a longer period. Remember, when planning for retirement, it is essential to consider both your life expectancy and that of your partner.
- Taxation: Since you withdraw money from your retirement fund in different financial years, the impact of tax on how much you can withdraw each year may be different.
Therefore, when considering retirement planning, it is crucial to clearly define the costs under the various scenarios discussed above and optimize them based on defined assumptions, considering both the worst-case and best-case scenarios before you select the right financial products and asset classes to invest.
One thumb rule to follow is to start executing your retirement plan from the day you receive your first salary cheque and adjust it as life scenarios change. Remember to optimize your financial journey for your goals, not the markets.