Preeti Kulkarni, ET Bureau Nov 10, 2014, 01.34PM IST | Economic Times
If you dream about a comfortable retirement but are planning to depend solely on your Provident Fund (PF) to meet your needs, be ready for a shock. The PF can be an important pillar in a retirement plan, but the corpus of the average subscriber is likely to fall woefully short of his requirement. One needs to make additional investments to build a corpus big enough to sustain one’s expenses for 20-odd years after retiring.
To be fair, the Provident Fund’s design makes it the most effective way to save for retirement. You start contributing from the very month you start earning, and since it is a compulsory saving, you can’t avoid it. Besides, your contribution is linked to your income and rises with every increment in your salary. If a person takes up a job at the age of 25, even a modest contribution of Rs 5,000 a month and a matching contribution by his employer can build up a massive corpus of Rs 6.89 crore over 35 years. This calculation assumes that his income (and, therefore, the contribution) will rise by 8% every year and the PF will give 8.5% returns.
While the figure of Rs 6.89 crore may appear huge, it may not be enough. If you need Rs 50,000 a month for living expenses today, a 7% inflation would push up the requirement to roughly Rs 5.34 lakh a month in 35 years. When you are 60, you would need a corpus of Rs 10.52 crore to sustain inflation-adjusted withdrawals for the next 20 years (see table). Assuming a post-tax return of 8.5% and 7% inflation, the Rs 6.89 crore from the PF would be completely wiped out in a little over 12 years. This could mean having no money in your retirement account at the age of 72.
There’s another problem. To make your PF work for you, you must remain invested for the long term. However, a lot of people withdraw their PF when they change jobs, thus losing out on the power of compounding. “In India, the PF is often used for other purposes, particularly when people change jobs. They end up withdrawing this accumulated corpus to buy expensive gadgets or go on a holiday, forgetting that the purpose was retirement planning,” says Arvind Usretay, India Retirement Business Leader, Mercer. A recent global survey by Mercer has ranked India’s retirement system the lowest among the 25 countries surveyed. “What continues to hold India back is the lack of retirement coverage for the informal sector and less than adequate retirement income expected to be generated from contributions made to the Employees’ Provident Fund (EPF) and gratuity benefits,” notes the Mercer study.
Another global study by Towers Watson points out that a significant majority of employees sees their employer retirement plans as the most important source of income in retirement. “Employers must educate their employees on the need for retirement planning and provide them the tools to help them save adequately,” says Anuradha Sriram, director, benefits, Towers Watson, India.
To ensure a comfortable life in retirement, one needs to make additional investments to build a corpus big enough to sustain one’s expenses for nearly 20 years in retirement. Here are a few options you can consider.
Mutual funds are, perhaps, the best way to supplement your retirement savings. Among these, equity mutual funds have the potential to give very high returns, but also carry high risk. They are best suited to younger investors who can withstand short-term volatility to earn long-term gains. “Equity funds should be the instrument of choice for young investors who have 25-30 years to build a retirement kitty,” says Suresh Sadagopan, founder of Ladder7 Financial Advisories. An additional advantage of investing in equity funds is that the gains are tax-free.
If you are averse to taking risks, consider a balanced fund, where the equity exposure is lower. Ultra cautious investors can go for MIPs of mutual funds that invest only 15-20% of their corpus in stocks and put the rest in bonds. However, the returns of MIPs will not be able to match those of equity and balanced funds.
Ulips have earned a bad name because of the rampant misselling in the past. However, this much reviled product can be a good option for retirement planning. In recent months, insurance companies have come out with online plans that levy very low charges. The Click2Protect plan from HDFC Life charges an annual fund management fee of 1.35%, which is less than the direct mutual fund charges. The Bajaj Allianz Future Gain plan does not levy premium allocation charges if the annual investment is Rs 2 lakh and above. The Edelweiss Tokio Wealth Accumulation Plan doesn’t have policy administration charges. Some Ulips, such as Aviva i-Growth and ICICI Prudential Elite Life II, don’t have lower charges but compensate long-term investors with ‘loyalty additions’. The best part in a Ulip is that one can shift money from debt to equity, and vice versa, without incurring any tax liability. The corpus is also taxfree on maturity.
Source : http://goo.gl/y5gCLT