By Romesh Angunawela
(This is the second in a series of articles by a financial advisor on preparing for retirement with proper retirement income. The first article appeared on November 11.)
As mentioned in my earlier article, planning for retirement has turned to be an important factor of an individual's overall financial plan as 58 percent of the Sri Lankan labour force is yet without a proper retirement plan. I also mentioned the risk involved in relying on all other government pension schemes (WOF, PSPF) due to the demographical change that will take place within the next 20 years.
The present method adopted by the government in funding retirees is through taxes collected from the present workforce. However, the significant factor that threatens this system is that the Sri Lankan workforce has presently a growth rate of only one percent per annum.
The affects of the current retirement schemes will not just affect the government employees but also those in the private sector, who contribute towards the Employment Provident Fund, etc. Thus, it is important to plan early, taking all relevant factors into consideration in order to ensure a comfortable retirement.
The first step involved in putting a proper retirement plan in place deals with the area of "determining retirement goals and estimating how much money is needed to achieve these goals". Retirement goals vary from person to person. A rich man would want the latest Mercedes in town, a mansion, a cottage in a foreign country, and an annual income of one hundred thousand dollars.
In contrast, a poor man would only want an income to maintain his day-to-day expenses (e.g. food, clothing, shelter, medical expenses etc.). However, the secret in planning early for retirement can put the poor man in the driver's seat enabling him to achieve the goals of a rich man. So, never underestimate your potential in achieving your retirement goals, as a proper retirement strategy, which is reviewed periodically, can get you to your retirement goal. Remember that the majority of the richest people in the world were not born rich.
Ask yourself the following questions:
a) How much money do I need on a monthly basis, as my retirement income?
b) What savings have I in place, to meet my retirement income?
c) Are my goals realistic?
Determining the amount needed at retirement depends on two key factors. They are as follows:
1) Lifestyle you wish to lead at retirement.
2) Age at retirement.
You should bear in mind that at retirement certain expenses keep falling while others increase. Planning ahead to have an adequate income to meet necessary expenses can be very useful. For example the possible lower expenses will be in the areas of clothing, commuting, etc. The possible higher expenses at retirement will no doubt be in the areas of health, medical care, recreational travel, entertainment, etc. Generally, a person needs at least 70 percent of his current net income for sustenance after retirement. However, since your current income has a direct effect on you achieving your goals, it is important to analyse all sources of current income in order to determine the sustainability of such income after retirement.
Undoubtedly, some of these incomes will not be available for you at retirement (e.g. employment income) though at times a proportionately reduced amount may come your way as a pension benefit.
Now, using all sources of income that can be sustained throughout your retirement, try to determine whether such income will meet at least 70 percent of your net current income. However, inflation should not be ignored. If the figure does not meet this necessity then a proper plan should be in place, to meet the shortfall.
Here is an example to elaborate the above in simpler terms:
Assume that Mr. de Silva aged 40 years, has a current income of Rs. 100,000 a month and wants to lead a comfortable retirement at 60. His current income is derived from the following:
In order to lead a comfortable retirement, Mr. de Silva needs at least Rs. 70,000 a month. Let us analyse the above sources of income.
Employment Income
Mr. de Silva will not be entitled to employment income at retirement but may qualify for a pension payment. However, the pension payment will not amount to Rs. 50,000 and may not be indexed properly to meet inflation. The other possibilities associated with Mr. de Silva losing his current employment income can be related to job risk and also having to give up work due to a serious illness, etc. Thus, Mr. de Silva should take appropriate measures to protect himself from such losses, (e.g. employment insurance, disability insurance, etc.)
Investment Income
Investments do have their ups and downs. Therefore, it is essential to find out the reliability of such investment income. Interest income, is based on the Central Bank's current rate of interest while financial institutions provide depositors with interest rates based on how risky their investment instruments are. For example a finance company may provide a higher rate of interest on a fixed deposit due to the high risk involved compared to a savings account of a conventional bank. It should be remembered that getting excited over a higher rate of interest might put your capital at risk.
Dividend income has no guarantee as it is linked to the relevant company's profits. However, dividends do offer some tax advantages.
Rental Income
Though fairly stable, a downward trend in the housing market may add pressure in finding the right tenant. Repairs and legal costs may also affect returns.
Business Income
This is directly linked to how profitable the venture is, and may have a significant impact on the capital if the venture fails to perform as expected.
The need for planning ahead
As with the current income that Mr. de Silva receives, in order to lead a comfortable retirement he should plan ahead to generate a fund that would provide him with at least Rs. 70,000 a month. If Mr. de Silva's current expenses on his current income of Rs. 100,000 is about Rs. 65,000, then he is only left with Rs. 35,000 a month to be invested within the next 20 years (Retirement age 60 years - current age 40 years = term available to invest) to meet the fund that will provide him with Rs. 70,000 a month. Thus, the fund that he needs in 20 years from now is a minimum of Rs. 8.4 million. And that should be indexed properly for inflation. The Rs. 8.4 million at a 10 percent rate of return will provide Mr. de Silva with Rs. 840,000 a year or Rs. 70,000 a month. Thus, Mr. de Silva's goal should be to save at least Rs. 8.4 million in the next 20 years and at all times should take inflation into account to ensure purchasing power at retirement.
What savings have I in place, for my retirement goals?
The current savings available will be of great importance, as it will reduce the need for regular savings in order to meet your retirement goals. However, saving extra will only make you achieve your retirement goals earlier. When estimating current savings available, one should take into account such things as, savings accounts, certificate of deposits, bonds, treasury bills, possible pension payments, etc. If there are items of value, which cannot be disposed easily, it is advisable that you do not take such things into account (e.g. antiques, art, real estate investments, etc.). Referring to the earlier example of Mr. de Silva needing at least Rs. 8.4 million at retirement to fund a Rs. 70,000 a month retirement income and if the current savings amount to Rs. 2 million, then it is only Rs. 6.4 million that will be needed at retirement (Rs. 8.4 million - Rs. 2 million = 6.4 million). This will significantly reduce the monthly commitment towards your retirement goals.
Are my goals, realistic?
Although dreaming of a very comfortable retirement is a good motivator in allowing you to achieve your retirement goals, it is always best to be realistic about such goals.
Disciplining yourself to save on a regular basis is the key to achieving short, medium and long-term goals. If you lack discipline, meeting your retirement goals would be a definite problem.
To be realistic is to set goals that can be achieved, taking into account your present circumstances. If you were to save Rs. 8.4 million by retirement having serious problems in budgeting your expenses, then you need to analyse the areas of unnecessary expenses.
In order to provide you with a proper financial plan to meet all your retirement goals, it is best that you seek professional help (qualified financial advisor, etc.). A professional will be able to spot areas of unnecessary expenses and may provide advice on how you could maximise your return, keeping in mind your risk tolerance and time horizon.
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