Avoid costly mistakes in retirement plans

Retirement planning is a crucial aspect of personal finance. Rising life expectancy, growing prevalence of nuclear families and lack of social security for the elderly have further increased its importance. Here are some suggestions to avoid common retirement planning errors.

Underestimating needs

Many investors wrongly assume a steep reduction in living expenses post retirement. While some expenses like commuting may reduce, rising chances of catching diseases, risks of injuries and other age-related health risks are likely to lead to a steady increase in healthcare expenses.

Another critical factor is longevity risk — the possibility of outliving your corpus. As medical advancements are likely to raise life expectancy, one should factor in a life expectancy of, at least 80 years while calculating retirement corpus.

People also tend to ignore impact of inflation on post-retirement costs. This can leave one with inadequate retirement corpus. For example, assuming average inflation of 6%, a 35-year-old spending ₹50,000 per month will need ₹2.15 lakh a month at age of 60 for the same lifestyle.

One can use online retirement calculators to calculate the monthly contributions for creating the corpus. Prefer calculators that consider key factors like current monthly expenses and expected inflation rates, among other things.

Not starting early

The most effective way to create a sufficient corpus without straining one’s finances is to start early.

For example, assuming a 12% annualised return, a 30-year-old investing ₹10,000 a month in equity mutual funds (MFs) via SIPs would have a post-retirement corpus of ₹3.5 crore in the next 30 years. Whereas a 45-year-old would require a monthly SIP investment of about ₹70,000 in equity funds for building same corpus in 15 years at the same rate of return.

Avoiding equities

Volatility leads many investors to avoid equity exposure in retirement corpus. However, equity as an asset class usually outperforms inflation rate and fixed-income instruments by a wide margin in the long term. This makes equities the most suitable asset class for achieving long-term financial goals like creating retirement corpus.

Avoid shifting entire retirement corpus to fixed deposits or other fixed-income instruments upon retirement. The long-term growth potential of equities can help reduce longevity risk to post-retirement corpus and thereby raise chances of retirement corpus outlasting lifespan. As individuals approach retirement, they should calculate sum needed to cover essential living expenses and financial goals due in the next seven years. Allocate that portion of post-retirement corpus to fixed income instruments like bank fixed deposits (with payout option) or short-term debt funds (with SWP activated) to generate regular income. The balance should be invested in equity MFs for wealth creation.

Not reviewing portfolio

Past performance of MFs does not guarantee future performance. Always review portfolio once every financial quarter. Compare MF scheme returns with benchmark indices and peer funds. Exit schemes that consistently underperform benchmarks indices and peer funds for over four consecutive quarters.

Employer health insurance

Employer’s group health insurance cease to cover staff and families after retirement. Relying on retirement corpus for the expenses can quickly deplete the corpus. The best way is to buy adequate health cover for self and dependents as early as possible. Extend the cover to post-retirement years as well. Buying health cover at a young age comes at lower premiums and there is broader illness coverage.

(The writer is CEO, Paisabazaar)