First, I need to accept that even though I’m not particularly eager to write about personal finance, I received good reviews about my writings on those subjects. Even this post came into my mind while I was thinking about one another issue and doing interviews and research for it. I learned that more than 80% of my respondents don’t have cover after retirement. Some of them know the importance but don’t have it. Not all of them have health insurance. Some of them invest in mutual funds, but there is no planning. It gives me a shock. There I realized that the potential of this subject is enormous. In the past, I wrote about it. But not much in detail. Now I am doing extensive research, Talking with many people, and making myself aware of bits and parts about it, So when I am writing, I know this will be lengthy.
I found my old blog post on it. Before going ahead, I request you to please read it once. When should you retire?
But I remember I did not do any survey for it. Today when I am doing it and reading my old writing, I realized that whatever I was writing at that time was not wrong, and the situation is not different in many countries. COVID 19 highlight some fault lines.
The concept
Retirement planning is not the thing that you start planning in your 40s.
I remember my grandmother told me that she retire around 60 year of their age. Though today the age of retirement maybe increased but COVID 19 is forcing to retirement age lower effectivly. In my generation people want to retire early but dont undertsand what does it means. they think that retirement means all enjoying their own time. Not having any 9 to 5 job. No stress. But they never realised that after retirement, their world willchange dreastically. I am sure not all of them thinkimg about responsibilities.
Retirement is a concept that assumes that after a certain age, your body will not be the same as it was some years before. So you need to stop working and take care of your health. At what age this will take place is a significant factor in answering many questions about retirement. Medical studies proved that at the age of 55 to 64, our bodies start showing signs of some chronic illness, as per the study conducted worldwide by the Center for Disease Control and Prevention with Medical Association. Even COVID19 patients who are above 55 are more vulnerable. So that is the right age for retirement.
Retirement myths
There are some myths about retirement, and if I forget to talk about them, this will not be the Blog post covering all aspects.
As the average lifespan of the human race is increasing, the retirement decision is becoming difficult. In my generation, many want to take early retirement. But I can say that not all of them are prepared. A large part may be ended up without a pension or any retirement cover. After a certain age, doing a 9 to 5 job is difficult. But your life is changing so does your expenses. It may be the same or increase. Inflation may show the effect, and you end up paying extra for many things.
Plan for a long retirement in calculating the amount you must save. If you don’t, you may outlive your retirement fund. And don’t forget the effect of inflation. At just 3% a year, inflation could reduce the purchasing power of your income by more than 25% in ten years.
Remember, however, that half of all early retirements are due to illness or disability. Also, finding good-paying jobs later in life can be difficult. The bottom line: Working past retirement age because you want to is a great goal, but it’s probably best not to rely too much on this income when making your retirement plans. It is best to take retirement at the right age.
Women need to save more for their retirement than men do. Statistics show that women live longer than men, but earn less than men during their working years (which are often fewer due to time taken off for child rearing). According to the Census Bureau, 57% of the population over age 65 are women, and 70% of older people living in poverty are women.
Many people make some big goals for their retirement—for example, world tours, buying a big house and car, and other things. Depending on your goals, you may be spending more in retirement than you thought, especially if you travel, visit children and grandchildren, and pursue new hobbies and activities. Another related misconception: You’ll pay less in taxes now that you’re retired. But that assumes you’ll have less income. If you end up with the same income in retirement as you had when you were working, you may not be in a lower tax bracket. Also, you may qualify for fewer tax breaks, such as a home loan may well be ended up. In addition, your child’s education expenses may not exist, and many others. At the same time, tax rates may rise in the future. Are you ready for all that?
Don’t rule out saving for retirement just because your income is low. If you contribute to an IRA or company retirement plan, you might qualify for a tax credit of up to $1,000. I dont know about other countries but in india, It is tax deductible.
Not a myth, but I found many people who think retirement planning is something not to do at the start of your Career. It may be easier to save for retirement later, but that’s irrelevant if your true goal is to find the easiest way to secure retirement. Time is on your side, which helps you when you are doing pension planning. If you start planning to say from 30 years, you have some good years in your hand so that you can take more risks, and even in a small monthly amount, you can achieve big goals. Having more than ten years for planning your retirement is always good as you can manage to take significant risks and effectively increase your retirement fund.
If you start late, your monthly installments are supposed to be more significant, or your rate of return should be more considerable, which is not in our hands. Many pension funds use this fact all over the world and add riskier assets in their portfolio, which are impossible for any other investors otherwise. For other investors, keeping commercial real estate, farmland, timberland, startups, InvIT, and REITs is something they want but cannot use. The reason is pension funds are investors for a long time. Therefore, they can distribute Risk over time. This is why starting early is essential.
For years, the standard advice was to build a retirement fund that would provide 70% to 90% of your pre-retirement income. But with longer life spans, steep medical costs, and higher costs in general, the replacement estimate has been increased to 126% of your pre-retirement income.
Another myth is your inheritance will take care of. Inheritance like agriculture, your real estate, if some company which you own. In some exceptional cases, yes. But not always. If your parents are not Jeff Bezos, Mukesh Ambani, or bill gates, you should consider retirement planning. Neither your spouse nor your children are going to take care of you.
Types of pension plans
If you are from the US, You know ROTH IRA and traditional IRA. NpakinFinance.com explains it better.
This is more like for the individual. But what about employees? Employers also have some liability towards it. That option is called 401(k) in the US.
Outside of this… Pension plans have two types.
- Defined Benefit plan
- Defined Contribution plan
Defined benefit plan
A defined-benefit plan is an employer-sponsored retirement plan where employee benefits are computed using a formula that considers several factors, such as length of employment and salary history. All type of Risk is on the Employer. The Employer administers the portfolio maintained for and investment risk of the plan. There are also restrictions on when and by what method an employee can withdraw funds without penalties. Benefits paid are typically guaranteed for life and rise slightly to account for the increased cost of living.
Also known as pension plans or qualified-benefit plans, this type of plan is called “defined benefit” because employees and employers know the formula for calculating retirement benefits ahead of time, and they use it to define and set the benefit paid out. This fund is different from other retirement funds, like retirement savings accounts, where the payout amounts depend on investment returns. Poor investment returns or faulty assumptions and calculations can result in a funding shortfall, where employers are legally obligated to make up the difference with a cash contribution. – Investopedia
Defined contribution plan
A defined contribution (DC) plan is a retirement plan that’s typically tax-deferred, like a 401(k) or a 403(b), in which employees contribute a fixed amount or a percentage of their paychecks to an account that is intended to fund their retirements. In addition, the sponsor company will sometimes match a portion of employee contributions as an added benefit. These plans control when and how each employee can withdraw from these accounts without penalties.
A little different version of this type exists in India. Government employees joined after 2005, and nearly all Employees of private sector enterprises don’t have defined pensions. Still, their Employer pays them a little higher salary as they are expected to use that and panned their retirement.
Healthcare expenses and Health Insurance
The people who watch FOX News and Supporters who support blindly the Republican party in the US are mad because they failed to understand that Obamacare and Affordable Care Act is the same. They blindly voted for someone who tried to snatch their healthcare when needed. Thankfully President was unable to trash it. But that highlights the need and the situation in the US when it comes to healthcare.
Health care costs are increasing each year even as life expectancies increase. Almost half of today’s retirees say they’re spending more on health care than they anticipated. By taking effect of inflation into account, this will going to be bad for my generation. It is better to cover their health expenses.
Understanding the time frame
While writing this, I remember some of our simple calculations during BBA. You are starting to make one portfolio by keeping the timeframe in mind. As you keep adding monthly or quarterly installments, your portfolio starts increasing. At one point, it will give you the exact amount you are adding. Like you begin adding per month $2000. At some point, your portfolio starts generating cash through dividends or interest.
Your current and expected retirement age creates the initial groundwork for an effective retirement strategy. The longer the time between today and retirement, the higher the level of Risk your portfolio can withstand. If you’re young and have 30-plus years until retirement, you should have most of your assets in riskier investments, such as stocks. Though there will be volatility, stocks have historically outperformed other securities, such as bonds, over long periods. The main word here is “long,” meaning at least more than ten years.
You might not think saving a few bucks here and there in your 20s means much, but the power of compounding will make it worth much more by the time you need it.
In general, the older you are, the more your portfolio should focus on income and capital preservation. This means a higher allocation in securities, such as bonds, that won’t give you the returns of stocks but will be less volatile and provide the income you can use to live on.
It would be best to break up your retirement plan into multiple components. Let’s say a parent wants to retire in two years, pay for a child’s education when they turn 18, and move to a place for retirement. From forming a retirement plan, the investment strategy would be broken up into three periods: two years until retirement (contributions are still made into the program), saving and paying for college, and living in your retirement place. (regular withdrawals to cover living expenses)
One essential part of your retirement plan should be repaying all your debt. Take extra efforts and pay all small and big debts on your retirement day. Debt is like an enemy of your retirement corpus. The only debt that you can keep is a mortgage on your home. But there is a strong possibility that it will not be there as many lenders make it in such a way that the mortgage will end with the end of your job.
Most people believe that after retirement, their annual spending will amount to only 70% to 80% of what they spent previously. Such an assumption is often unrealistic, especially if the mortgage has not been paid off or unforeseen medical expenses occur. Retirees sometimes spend their first years splurging on travel or other bucket-list goals. I found that your costs will not be lower after your retirement, but the quality will change. Like your expenditures on healthcare will increase. Travel expenses may increase as many people don’t want to take the extra Risk and may keep a chauffeur or someone who drives or uses a cab service.
“For retirees to have enough savings for retirement, I believe that the ratio should be closer to 100%,” says David G. Niggel, CFP, CFP, ChFC, AIF, founder, President, and CEO of Key Wealth Partners, LLC, in Lancaster, Pa. “The cost of living is increasing every year—especially health care expenses. People are living longer and want to thrive in retirement. Retirees need more income for a longer time, so they will need to save and invest accordingly.”
Accurate retirement spending goals help in planning as more future spending requires additional savings today. “One of the factors—if not the largest—in the longevity of your retirement portfolio is your withdrawal rate. Having an accurate estimate of what your expenses will be in retirement is so important because it will affect how much you withdraw each year and how you invest your account. If you understate your expenses, you easily outlive your portfolio, or if you overstate your expenses, you can risk not living the type of lifestyle you want in retirement,” says Kevin Michels, CFP, EA, financial planner, and President of Medicus Wealth Planning in Draper, Utah.
Risk-taking ability? (decisive factor for retirement planning)
Not which asset class you choose but what type of person you are that matters the most while investing.
Here I want to tell you some basics about three personalities. The portfolio Management theory classifies investors into three types—risk-seeking, Risk neutral, and risk-averse. I can easily explain this if one gives the option of receiving 50 Rupees for sure and another option that needs him to gamble for a 50% chance of getting 100 rupees. The average person will always choose the first option even when the reward percentage is the same.
In other words, the one person with the more extensive risk-taking ability will go for the gamble. That is risk-loving or risk-seeking. So the neutral one is indifferent, but the risk-averse one will choose the 50 rupees.
Portfolio theory explains that risk-taking is a utility for some. Simply put, the adrenalin rush can come in any form, sky diving, bungee jumping, scuba diving, etc.
I agree that pension and retirement are not places to take an unexpected risk. But If the person is risk-seeking, it must be taken into account that in his retirement, he may try to search for the utility of Risk. So it is necessary to take all the measurements.
I need one more decision: how do you want it after retirement. Lumpsum or annuity? Don’t go for only one option. As an advocate for the Emergency funds, I know that the need for such funds increases after retirement. So keep the right mix of both. At least part (10-15%) as Lumpsum and keep that in liquid cash format easily accessible. Remember that this is nothing to do about earning interest on this amount. This amount is all for cash requirements in emergencies.
After writing so much, I can tell you that it is better to keep this management in professional management. But if you have all the knowledge and want to manage it…
What is right? Retirement DIY or professionally managed fund.
An exciting thing I found while writing is that no one advises DIY on the internet. Pension planning is something niche in investment that has evolved. Directly or indirectly, many investors invest for their retirement—the decisions needed while retirement planning are some of the costliest when it comes to opportunity costs. One wrong decision and all gone. Many asset classes have different characteristics. However, they all are helpful in different situations. REIT and Asset-backed securities are other, but both can work better in the right portfolio mix. At what level it is right to take the Risk of credit opportunity and when to go for Gilt fund even if others are looking better. In a hedge fund, which strategy is right and which manager is better. Even people will keep advising you for equity; private equity can give you some good returns but is difficult to access. Making money double in startups is easy, but which startup is proper, and at what stage of retirement investing are you supposed to support?
Home equity is one way to take extra debt, not in India but in the US. A reverse mortgage is also used as a source of income after retirement. I am not aware of bits and parts but take one precaution: if you lived longer than what was estimated, please check the clause about such a situation as the life expectancies are supposed to be longer. If that takes place, you will be in the ’80s. So I am sure living homeless in the ’80s was not a good idea.
Mutual funds are one middle ground you can keep an eye on, and still, professionals manage it. But still, there are many things to see. From the start of working the mutual fund for retirement to the day of retirement, your risk appetite is not the same. It keeps changing. So at what level you are supposed to change the type of mutual funds is essential; for that, you need to have one financial advisor.
Financial advisor: Importance
While writing about the post, I mention that you need a financial advisor, not even the financial decision but many other decisions, and I am still firm on it.
For writing this, I was going through all types of pension plans. I saw thousands of them. Some of them I came t know that they are good. Some of them are bad. But some of them are difficult to understand. When a blogger can understand one, forget that a common many can understand it. It is more important to calculate your need and make a little more.
It is always better to keep more funds then ending up low coverage.
If you are checking five years performance of the mutual fund, check what all assets are. Ask the customer care department or marketing department.
One last thing I will say is that your job may give you a Financial windfall, and you can easily use them to keep some of your retirement goals ahead. for that pls, read my post on how to use Financial Windfall for Better Financial Position
