It could mean having to prolong work life and putting money in risky investment options
Arvind Rao | April 25, 2015 Last Updated at 21:25 IST | Business Standard
It’s a dilemma several middle-aged parents grapple with. Two goals – retirement and saving for children’s higher education – but not enough funds to meet them. Parents would be tempted to compromise on the former to meet the latter. But with medical costs rising exponentially, this can’t be looked at as a viable solution. This could also mean extending their work life or taking greater investment risks closer to retirement.
Here’s a case study that shows how one can strike the right balance. Ajay and Varsha Sharma, aged 50 and 48 respectively, earn Rs 40 lakh annually, which is not enough to fund all of their major goals. They have to repay their existing home loan of about Rs 40 lakh in the next five years. The couple needs Rs 4.5 crore for retirement and Rs 70 lakh in the next 10 years to fund the higher education of their two children.
The family savings work out to about Rs 15 lakh a year. Their employment-linked retirement benefits and 1 BHK property investment is expected to fetch Rs 2.12 crore, or 45 per cent, of their retirement corpus. This leaves them with a gap of Rs 2.48 crore, or about 55 per cent of the total corpus.
To fund the gap, the Sharma’s can invest Rs 10 lakh per annum in a mix of diversified and mid-cap equity funds. Assuming annualised returns of 12 per cent, they should be able to garner Rs 2.48 crore over the next 12 years.
At the current EMI of Rs 54,000, their home loan outstanding at about Rs 40 lakh is projected to close at the end of 10 years. They aspire to accelerate the repayment and close the loan in four years. For this, they will have to accumulate at least Rs 6.50 lakh annually via monthly contributions in recurring deposits. At the end of every year, the accumulated amount should be used to prepay the loan.
The amount of Rs 70 lakh for higher education can be mopped up by investing about Rs 4.5 lakh per annum over the next 10 years in equity-oriented balanced funds, assuming annualised returns of 10 per cent.
With the current family savings, they are looking at a deficit of about Rs 6 lakh per annum, at least for the first five years.
Part-funding children’s education
The couple has decided to make a provision for up to 50 per cent of their children’s higher education budget by extending the period for their accelerated home loan. They can cut the savings rate for the repayment by 50 per cent to Rs 3.25 lakh a year, thereby extending the period for their home loan repayment to about six years. This way, their contribution for the education also comes down to about Rs 2 lakh and savings for all three goals fit within the family savings. The additional family savings at the end of the home loan period could be used to boost retirement savings or for their children’ marriages.
To accumulate the remaining 50 per cent of their education corpus, Sharma’s children can fall back on scholarships. They can also meet the expenses through education loan or loan against fixed deposits:
Education loan: Interest rates on these are 11-12.5 per cent, with tax benefits available under section 80E. A good retirement corpus, in the form of investments, will enable one of the parents to stand as guarantor/co-applicant for the loan. For loans above Rs 4 lakh, margin money, ranging between 15-20 per cent of the loan, may be required, which can be funded by the parents.
Loan against fixed deposits: Let’s assume the Sharma’s garner a corpus of about Rs 2.5 crore at the time of retirement, which they don’t fully need immediately. They could invest, say, Rs 25 lakh in a bank FD giving 8 per cent per annum and take an overdraft against the same for their children’s education. The rate of interest charged in case of overdraft will be 1-2 per cent higher than the FD interest rate. Even assuming a 10 per cent rate of interest, this option works out to be cheaper than an education loan, but the interest paid will be sans tax benefits under section 80E.
The parents can make the children responsible for repaying the overdraft with their earnings. This will enable them to get their fixed deposit back along with the accumulated interest, which can then be utilised for their retirement. The Sharma’s should avoid loans against property as the EMI would be calculated only for their balance working years, which could mean a bigger outgo per month, plus no tax benefits on the interest paid thereon.
Funding education completely
In case the Sharma’s decide to fund 100 per cent of their children’s education and continue with the six-year home-loan closure plan, they would need to set aside Rs 7.5 lakh per annum and work for two more years to fund their retirement corpus. The Sharma’s may have to invest more aggressively, allocating as much as 75 per cent of their savings in a mix of equity mid- and small-cap and sectoral funds, and the remaining 25 per cent in balanced funds to achieve an 18 per cent growth rate and retire within the next 12 years. This strategy, however, may expose the Sharma’s to a bigger risk of not achieving their target corpus within the available time frame if the equity market do not deliver good results. Considering these risks, it is definitely better for them to part-fund their children’s education needs and not compromise on their retirement goals.
The writer is a chartered accountant
Source : http://goo.gl/lNXl7d
Gaurav Mashruwala, TNN | Apr 25, 2015, 07.08AM IST | Times of India
Mohit Khullar (31) lives with his wife Manika (28) in Haryana. He was born and brought up in Punjab. They have a two-year-old daughter, Ashwika. Mohit is an electrical engineer and currently works in the private sector while Manika is a homemaker.
What is the couple saving for?
They want to purchase a house worth Rs 45 lakh two years later as an investment. Rs 50,000 for Ashwika’s education two years from now. A corpus of Rs 15 Lakh after 24 years for Ashwika’s marriage. For their retirement, the couple wants Rs 1 core after 30 years. Apart from these goals, they also wish to own a luxury car worth Rs 10 lakh after four years and go on foreign travel.
The costs will be revised based on inflation.
Where are they today?
Cash flow: The gross annual inflow from all sources is Rs 12.48 lakh against an outflow of Rs 8.05 lakh. The outflow includes routine household expenses, taxes, insurance premium and contribution to provident fund
Net worth: The market value of all assets owned by the couple is Rs 21.31 lakh. Out of this, Rs 3 lakh is for personal consumption in the form of car. The rest are investments. They do not have any liability as of now. The house that they are living in is owned by Mohit’s parents.
Contingency fund: Against the mandatory monthly expenses of Rs 44,000, balance in savings bank and FD together amounts to Rs 2.80 lakh. This is equivalent to 6 months’ reserve.
Health & life insurance: There is a Rs 3 lakh health cover provided by employer for the entire family. Total life insurance of Mohit is Rs 40 lakh, out of which Rs 30-lakh cover is provided by the employer.
Savings & investment: Assets for savings and investment include Rs 2 lakh in savings bank, Rs 80,000 in bank FD, Rs 4 lakh in direct equity, Rs 50,000 in bonds, Rs 86,000 in a provident fund and Rs 15,000 in post-office schemes.
The couple’s rate of savings is good. The balance in savings bank should be reduced and they must enhance health and life cover. Most assets are investment-oriented because they are living in their parental house.
The way ahead
Contingency fund: Their three months’ mandatory expense reserve should be around Rs 1.30 lakh. Of this, they should keep about Rs 30,000 in form of cash at home and the rest in savings bank account linked to a fixed deposit.
Health & life cover: Mohit and Manika should have a health cover of Rs 5 lakh each and Rs 3 lakh for their daughter. Considering Mohit is single earning member of the family, he should opt for a life cover of Rs 1 crore for now and increase to another Rs 1 crore in next four to five. All these policies should be in form of term plans.
Planning for financial goals
Home buying: Since they do not need a house for staying, they should defer this goal for another decade. This is keeping in mind the fact that there is lack of funds currently and overall portfolio will get skewed in favour of illiquid, immovable, indivisible asset if they purchase a new house now.
Daughter’s education: They should invest Rs 2,500 every month in recurring deposit.
Daughter’s marriage: The should start an SIP of Rs 3,000 in and equity based mutual fund and another Rs 2,000 in a gold fund and increase the amount by 15% every year.
Retirement planning: Invest Rs 7,500 each in three equity mutual fund schemes: Large-cap fund, mid-small cap fund and an international equity fund every month — increase the amount by 10% every year.
Foreign travel: Set aside funds from regular income to fund the trip.
Luxury Car: Defer this goal for a few years.
Young couples with clear goals, humble expenses, high savings rate and living with parents. For them these are golden wealth creation years. If they stay focused like this for another 5/7 years, they will be on massive wealth creation trajectory. Usually it just requires about a decade of frugality in entire career to create wealth. If that is done during initial period of life it is more beneficial.
Source : http://goo.gl/d3PWVT