Why should we plan for Retirement as soon as we start working?

If we talk to some young person about retirement who has just got his first job, he may definitely laugh on us.  In India there is almost no seriousness for retirement planning and talking to someone who has just started working is too long for planning. At the mass level, people are very short sighted and plan for their short term goals, but not “long term goals”

Why retirement planning is important?

As we all know the inflation is the biggest enemy for any person who need to survive in future. Although the inflation numbers may not look very high in govt. statistics but if we talk about actual cost of living the numbers are quite different. If we assume 10% rise every year in our cost of living then for every 7 years, we require almost double of the amount to maintain the same cost of living.

So for a 30 year old person if we assume he would retire at 58 then the money required for same life style will be 16 times of the current value. Yes it’s not a small number. If a person’s monthly expenditure is 25000 today he will need about 4 lakhs at the time of retirement.

But still people don’t plan for retirement, why so? Let’s understand the reasons and also why we should actually plan it.

1. It’s too early

As mentioned above, most of youngsters feel that I have just started working so I have different priorities. The top most thing in his mind right will be “how to buy the house?” or a New Car and maybe how to get the better pay package in the next job?

Thinking of retirement at this age is simply too much when there are so many other things before that. But the fact of life is that everything comes on its time and if we have not planned it in advance we have to suffer at that time and we can’t go back to plan again. So let’s plan the things when we have time to control it.

2. My Kids will take care of me

In India there is a famous saying that our children are “Budhape ka Sahara” this holds true even today for many of us and yes we have much better social fabric compared to western countries and lot of children take care of their old parents. But still there are many people who don’t want to be dependent on their kids. They want to give the best to their kids and raise them as amazing people, but then they do not expect anything back from them.

There was a famous movie “BAGHBAN” of Super star Amitabh Bachhan which reminds us of some hard truths about life. It’s good that our children may take care of us but should we totally dependent on them?

3. Don’t have Money

This is a very common reply if we ask some youngster. It’s getting tough to save in today’s times especially if you are single earning member in family with 5-6 people in a big city. Since this is last priority for a young person and he have got so many other expenses lined up that for retirement there is no money left.

But the hard core truth is “Just because you were not able to save enough for future, no one is going to give you money at your retirement.”  So let’s control the expenses and start saving whatever little we can start with and increase it gradually.

Even if we start saving small amounts we can create a good corpus if we continue for a long time. For example Rs. 5000 saved every month can create a corpus of about Rs. 2 cr in 30 years (assuming annual return of 12.5%).

4. We can’t visualize for so long

Future is unknown and uncertain, and generally we can’t predict what will happen after 10-20 or 30 years later so we also don’t worry about it much. Therefore most of us are unable to visualize how serious it is to plan for retirement and how tough it will get if they do not have enough retirement corpus.

It’s not easy to look far ahead in future and visualize it especially when we have a very active income right now. Just like its very tough to image how it feels to be hungry, when we are easily getting 3 meals each day. Our salary/regular income will stop coming and still we have to live another 30-40 years, its not that easy we don’t have enough money to take care of regular expenses including rising medical bills.

As we become older, our health will not be at the best level and kids will be busy and struggling with their own life issues hence may not be in position to take care of in the same way we had expected.

There are various examples of successful people who died poor and struggled in their retirement life. If we do not have enough money at retirement, we do not have power. People do not treat well, and that’s the harsh reality of life.

5. So what should we do?

We should do some basics to create a retirement corpus, which will be as follows:

1. First calculate the time of retirement

2. Find out currently monthly expenses and amount required at the time of retirement.

3. Calculate the corpus required and amount to be invested to achieve it. Take professional advisor’s help to get the clear picture.

4. Invest among different asset class i.e. equity & debt to diversify the portfolio

5. Be debt free at the time of retirement

6. Be disciplined in the investment. Invest regularly and increase it as the income increases.

7. Don’t touch the retirement corpus for any other purpose.

How to counter Long Term Capital Gain Tax

Finally the biggest fears of equity investors has become a reality now. Much speculated long term-capital gains (LTCG) tax on equities is back. The proposal of LTCG made by the Finance Minister on 1 February 2018 rattled the stock market, sending the markets on a downward spiral. The Sensex is almost 2,000 points down since the announcement. Although grandfathering of capital gains till 31 Jan 2018 i.e. LTCG earned up to this date won’t be subject to tax—prevented the market from plummeting on Budget day, but it could not rein in the fall the day after as there are other negatives like continuation of STT, not providing indexation benefit to long-term equity investors, etc. later will keep the sentiments down for the time being.

1. Impact of LTCG

As proposed the LTCG tax is 10% without indexation for equities. Currently for Debt funds there is 20% LTCG tax with indexation benefit.

If we assume a return of 10% from both equity and debt funds and 5% inflation.

The effective return post LTCG tax on debt funds works out to be 9% {10- (10-5)*20%}.

And for equity also it will be 9% (10-1)%.

So if the returns are less than 10% then indexation benefits (assuming 5% inflation) will reduce tax liability and for more than 10% returns the 10% straight tax (without indexation) improves the returns for the investors.

Normally we expect 10%+ returns in the equities so indexation may not be very helpful in that case. However there is also STT (Securities transaction tax) of 0.1% which will reduce the net returns a little bit.

2. Who will be impacted?

       i.          (i) Individual investors who are investing in Equities or Equity Mutual funds have to pay the   tax.

 (ii) Being trustee of investors’ money, Domestic mutual funds/Insurance companies, don’t   have to pay LTCG tax so for them there will be no impact. Only the investor when he   redeems need to pay the tax.

(iii) FIIs i.e. foreign institutional investors will have to pay tax on their trades which will push up their costs. Also, though the grandfathering clause provides some relief, it increase their operational costs due to tax compliances.

3. What will be the impact on Market?

Now after the introduction of LTCG tax, the difference between the STCG and LTCG is only 5% now. Due to this few investors may wait for a year to sell. Investment decisions will now be based on the market situation and not based on tax concerns as the 5% difference between LTCG and STCG, will not be so lucrative for investors to wait for an entire year just to avail of this extra  tax benefits. Earlier even if they wanted to book profits they normally use to stay invested for minimum one year just to get the gains tax free now this will not be the case.

This will result into more volatility in the stock market.

4. So what can an investor do?

Government has proposed that LTCG on equities will be tax free up to ₹1 lakh per financial year. So for small investors it may not impact much. For example if an investor is investing 5000 monthly SIP and expected return is 12% the total capital gain would be approximate 1.12 lakhs after five years. So by taking some redemptions in between he may not be required to pay any tax. Or for one time investor who has invested 8 lakhs and with 12% returns it comes just 96000 so no need to pay tax on the entire gain.

With a 10% Dividend Distribution Tax (DDT) being introduced on Equity Mutual Funds only, the overall outgo in hand of investor will reduce marginally. However the MF dividend remains tax free in the hands of the investor. This is specifically for retirees. So it is better to avoid dividend option in mutual funds.

However for large investors there will be an impact which can be reduced to some extent by constantly booking profits on regular intervals.

Since we can’t carry forward the ₹1 lakh sum—hence we cannot claim ₹10 lakh exemption over a 10 year period. So, we will have to book profits each year. “Instead of accumulating capital gains forever, investors now need to churn their portfolio (book profit and invest again in other assets) on a regular basis to lower their tax liability.

So for very small investors there may not be any effect if they book profit time to time and for large investors they may have to pay some tax and hence to achieve their goals they may be required to increase the investment amount by 10-12% so as to achieve their pre decided goals.

To Conclude

It is more important than ever to stop churning the portfolio of MF in the name of “More Returns” or “Asset Allocation”. as we may save the 1% exit load but will incur the 10% LTCG., so we should redeem only to book profit when it is reaching 1 lakh limit or the scheme is not doing good.

Remember, the risk is in our investment strategy not in the market. If we have put together an investment for a Financial Goal no other asset class except equities (even after LTCG) will allow us to achieve it.

Finally we must consult our advisor to define priorities and risk profile before starting investments. It’s even more important with the new tax regime in place.