This is the first article coming in the Retirement Planning series that IndianMoney.com is publishing for our readers. Today we will discuss about the meaning, importance and advantages of Pension Planning. Our objective is to make aware all the people about the importance of Retirement Planning. We are sure that after reading this series of articles you will be able to take a better decision on your Retirement Planning.
Retirement is one of the major important life events many of us will ever experience. From both a personal and financial viewpoint, realizing a comfortable retirement is an extremely extensive procedure that takes sensible planning and years of perseverance. Even once it is reached; managing your retirement is an ongoing accountability that carries well into one's golden years. Although all of us would like to retire happily, the difficulty and time required in building a successful retirement plan can make the whole procedure seem nothing short of daunting. However it can often be done with fewer headaches (and financial pain) than you might think - all it takes is a little homework a possible savings and investment plan and a long-term commitment.
A pension plan is an assurance by a pension plan sponsor to a plan member to supply a pension after your retirement. In this article we'll break down the procedure needed to plan implement, execute and eventually enjoy a comfortable retirement. Retirement planning basically is planning for a stable income after retiring from regular work. It is an investment choice where the returns are allocated after a gestation period. Individuals investing in retirement profit schemes usually earn pension over an extended period. Planning for retirement earning is best done throughout the course of regular job or practice. Saving frequently is the initial step towards planning for investment. The earlier an individual starts saving the higher is the amount of investment possible. All investments yield interest and rate of interest earned on longer terms generally outweighs inflation rates.
Two important kinds of pension plans
Generally a Pension Plan is a way in which an employee transfers part of his or her current income stream towards the retirement income. There are two main kinds of pension plans:
- Defined-benefit plans
- Defined-contribution plans.
In a defined-benefit plan the employer guarantees that the employee will be given a definite amount of benefit upon retirement regardless of the performance of the underlying investment pool.
In a defined-contribution plan the employer makes predefined contributions for the employee but the final amount of benefit received by the employee depends on the investment's performance. In common a pension is an agreement to provide people with an income when they are no longer earning a regular income from employment. The terms retirement plan or superannuation refer to a pension settled upon retirement. Retirement plans may be set up by employers, Insurance companies, the government or other institutions such as employer associations or trade unions. Retirement pensions are classically in the form of a guaranteed Annuity.
A pension created by an employer for the benefit of an employee is commonly referred to as an occupational or employer pension. Labor unions, the government or other organizations may also fund pensions. Occupational pensions are a form of deferred compensation generally beneficial to employee and employer for tax reasons. Many pensions also contain an insurance aspect since they often will pay benefits to survivors or disabled beneficiaries while annuity income insures against the risk of longevity. Other vehicles may provide a similar stream of payments. The general use of the term pension is to explain the payments a person receives upon retirement usually under pre-determined legal and or contractual terms. A receiver of a retirement pension is known as a pensioner or retiree.
Types of pensions
- Employment-based pensions (retirement plans)
- Social / state pensions
- Disability pensions
Employment-based pensions (retirement plans)
A retirement plan is an agreement to provide people with an income during retirement when they are no more earning a steady income from employment. Often retirement plans require both the employer and employee to contribute money to a fund throughout their employment in order to receive defined benefits upon retirement. Funding can be provided in other ways such as from labor unions, government agencies or self-funded schemes. Pension plans are therefore a form of deferred compensation.
Social / state pensions
Many countries have shaped funds for their citizens and residents to provide income when they retire or in some cases become disabled. Normally this requires payments during the citizen's working life in order to succeed for benefits later on.
Some pension plans will offer for members in the event they suffer a disability. This may take the form of early entry into a retirement plan for a disabled member below the normal retirement age.
Criteria for choosing a retirement plan
After deciding for investing in a retirement scheme, it is significant to understand the benefits of the same. The criteria for selecting a retirement plan are:
- Terminal bonus
- Life coverage
- Compounded returns
Bonus is an important measure for choosing a retirement policy. Some companies pay bonus on the total money invested while others pay bonus on the premium amount.
In addition to yearly bonus, certain companies also pay terminal bonus.
A few companies supply life coverage to investors and are always the improved option compared to companies that do not.
The interest payable is also simple or compounded. Since compound interest is always higher on a given main sum compared to simple interest, investing in a plan yielding compounded interest is preferable.
Factors effecting your retirement planning
However the key to retirement planning success is to begin early and gain the benefit of the power of compounding. To start with, first explain why you should start planning for retirement at a very young age. Below given are the factors effecting your retirement planning.
- Life expectancy
- Medical emergencies
- Nuclear families
- Job hopping
- No government sponsored pension plan
As of 2007 the life expectation at birth for males is 67 years and 71 years for females. With development in technology life expectancy is likely to increase. As a result, you will have to go for more number of years post retirement.
With age come health problems. With health problems come medical expenses which may makes a huge dent in your income post retirement. Failure here could guide you to liquidate (sell) your assets in order to meet such expenses. Remember Mediclaim do not always be sufficient.
The days are gone when people use to have a complete cricket team making a family. Today's youth prefer not more than two children. With westernization coming in, the traditions of joint family are changing. They prefer freedom and stay away from their family. Therefore people have to develop a corpus to last them during their retirement without any help from family.
As you require worrying about it you need to account for it as well. You need to take into account inflation while calculating your retirement corpus as well as your returns.
With youngsters hopping jobs frequently they do not get benefit of plans like super annuity and gratuity. Both these require certain number of working years spent in the service of an exacting employer.
No government sponsored pension plan
Unlike the US and UK where they have IRA (Individual Retirement Arrangement)and state pension respectively as social security benefit during retirement, the government of India does not give such benefits. So again it is your responsibility to fund your Retirement.
Why should you start early for Retirement?
Let's take an example to know it better. Say X is 28 years and wants to retire at 60. She or he has 32 years to go (considering pension age as 60). If s/he starts investing Rs 1,500 per month for the next 30 years then at the rate of 15 per cent (assuming s/he is doing a systematic investment plan in equity mutual funds) s/he will have a corpus of Rs. 1.03 crores. Whereas if you don't begin at an early age and at 50 you decide to start investing then to have a corpus of Rs. 1 crore you will need an investment of Rs 41,500 per month!
While this may not be probable starting your retirement planning when young is. It is not needed to start with a bang. You can start with small amounts and raise it as your salary increases. Also if you start early and you have time with you, you can gain benefit of high returns and maximize your investments by investing in equities or equity mutual funds.
to know about the benefits of Pension Plans
How much would you require at retirement
There is no single number that would assure everyone a sufficient retirement. It depends on many factors counting your favored standard of living, your expenses including any medical costs and your target retirement age. It is totally possible to decide a sensible number for your own retirement needs. All it involves is answering a few questions and doing some number crunching. As long as you plan ahead and estimate on the conservative side it is completely probable for you to collect a savings enough to last you throughout your golden years.
Your first step in the procedure is to decide the amount you will need to maintain through your retirement. Research shows that normally 80 to 90 per cent of a person's pre-retirement income suffices to preserve her/his current standard of living. You might argue that your standard of living is bound to go higher with raise in your income and so will the expenditure. Hence you have to take into account raise in your annual income over the years. The components to be taken into account when calculating your retirement corpus/returns are:
- Your current age
- Expected age of retirement
- Life expectancy
- Years after retirement
- Current earnings
- Expected annual growth (in percentage) in income
- Annual income at retirement age
- Rate of return on retirement corpus (in percentage)
- Inflation rate (percentage)
- Inflation adjusted rate of return/Real rate of return (in percentage)
After calculating your retirement requirement the next step would be to find the amount essential to save to reach there. The components involved to derive this figure are:
- Rate of return during accumulation stage (in percentage)
- Existing invested corpus
- Number of years to retirement
Steps involved in determining the requirement for Retirement Plan
Step 1: It is very significant to work out the intended expenses after retirement. Planned expenses vary from individual to individual and from one city to another.
Step 2:Listing of present wealth and investments gives an indication of the gap accessible between the actual earning potential and the preferred expenditure
Step 3:After identifying this gap plan investments hence which take closer to your preferred expenditures
Step 4:The risks concerned in these future investments are of fundamental consideration.
Step 5: A constant review of available investments helps to mix and match future retirement income plans.
Retirement advantage investment plans are offered by banks, non-banking financial institutes and government agencies. In many countries post offices also expand retirement investment plans.
How to find the size of savings you'll need in order to fund your retirement
The reason behind listing these components is to clarify that it is not merely accumulating Rs. 1 crore for retirement. The right retirement corpus is one which helps you preserve your standard of living even after retirement. There are several key tasks you require to complete before you can decide what size of savings you'll need in order to fund your retirement. These include the following steps:
Step 1: Choose the age at which you want to retire.
Step 2: Decide the yearly income you'll need for your retirement years. It may be wise to estimate on the high end for this number. Normally speaking it is reasonable to assume you'll need about 80% of your current annual salary in order to maintain your standard of living. Add up the current market value of all your savings and investments.
Step 3: Determine a practical annualized real rate of return (net of inflation) on your investments. Conservatively assume inflation will be 4% annually. A realistic rate of return would be 6-10%.
Step 4: If you have a company pension plan, gain an estimate of its value from your plan provider.
Step 5: Estimate the value of your social security profit.
Two things to Remember about Pension Plans
Give every year to your pension fund; you might want to skip a year's payment thinking that skipping a year will not make much of a difference. You might be wrong. Systematic investment instills discipline and this is a key to accumulating a bigger corpus.
Resist the temptation to withdraw. If you are not capable to contribute after 15 years since of some personal problems do not remove money from your retirement savings and let it grow for the next 15 years unless in case of extreme emergency.
Planning for your retirement is an on going process. It requires discipline, self study and time. The earlier you start the better it is as you can gain from the power of compounding as well as aim for a higher return.
is one of the main important aspects of planning. Remember that medical expenditures are never foreseen. Mediclaim supports us in emergencies. At times it may not be enough but it certainly offers a buffer. So it is very important to check that your Mediclaim premium is paid every year and it does not lapse.
Sources of Income to Invest
Following are the important sources of income, which will help you to invest in pension funds.
- Employment income
- Employer-Sponsored Retirement Plan
- Current Savings and Investments
- Other Sources of Funds
As you grow through your working life, your yearly employment income will possibly be the largest source of incoming funds you receive and the major component of your contributions to your retirement fund. For your retirement plan simply mark down what is your after-tax yearly income is. Then deduct your annual living expenses. The amount left over represents the discretionary savings you have at your removal. Depending upon how the numbers work out you may be capable to save a large part of your employment income toward your retirement or you may only be capable to save a little. Be sure to use a budget and comprise all your recurring expenses. One way to guarantee you save the projected amount for retirement is to treat the amount you plan to save as a recurring expense.
Regardless figure out the maximum amount of your employment income you can give to your retirement fund each year. Also if you are capable to work part time throughout your retirement years include this information in your retirement profits calculations. For example let's think that Harsh's after-tax earnings are Rs.34,000 and her living expenses are Rs.2,000 per month or Rs24,000 per year and that she will not be working during her retirement. Thus Alison has 10,000 per year of optional savings. She can decide to contribute all of this money to her retirement plan or she can give a portion of it to her retirement fund and spend the rest on a vacation or something else she desires but we know that her available retirement funds from her employment income add up to 10,000.
Employer-Sponsored Retirement Plan
You may or may not join in a retirement plan
during your employment. If you don't, you will require focusing on your other income sources to fund your retirement. If you do participate in an employer plan contact your plan provider and acquire an estimate of the fund's value upon your retirement. Your plan supplier should be able to give you an estimated value of your retirement funds in terms of a monthly allowance. Obtain this number and add it to your list of retirement income sources.
Similar to your social security profit the funds from your employer plan can help cover your living expenses during your retirement. However most employer plans have rules regarding the age at which you can start receiving payments. Even if you quit working for your company at age 50. For example your employer plan may not permit you to begin receiving payments until age 65. Or they may allow you to start receiving payments early but with a penalty that reduces the monthly payment you receive. Talk to your plan provider to decide what rules apply to your employer plan and consider them when you are making your retirement plan.
Current Savings and Investments
Also consider what current savings and investments
you have. If you previously have a great investment portfolio, it may be enough to cover your retirement needs all by itself. If you have yet to start saving for your retirement or are coming into the retirement planning game late, you will require to compensate for your lack of current savings
with greater ongoing contributions.
For example with Raj's retirement plan he previously had a Rs. 100,000 retirement fund at age 40. Reasonably assuming this fund grows at a real rate of return of 6% per year until he is 65, Raj will have about Rs. 429,200 in today's Rupees by the time he is 65. Depending on other sources of income he has could be sufficient to fund his retirement so that Raj does not have to give large amounts of his ongoing employment income.
If you do have current savings and investments are sure to comprise only the portion you expect to have left over by the time you have reached retirement. Don't include any portions you're planning to leave for your children or spend on other assets such as a summer home which will make the funds unavailable for covering your living expenses.
Other Sources of Funds
You might have other sources that will be obtainable to fund your retirement needs. Perhaps you will get an inheritance from your parents before you reach retirement age or have assets, such as real estate that you plan to sell before retiring. Whatever additional sources of funds you do happen to have been sure to comprise them in your retirement projections only if they are certain to occur. You may be expecting to realize a large inheritance from your parents but they may have other plans for their surplus savings such as donating them to charity.
Other unexpected cash inflows may also come along as you build toward your retirement such as lottery winnings, gifts, raises or bonuses, etc. When you do occur to receive these additional cash inflows, believe adding them to your retirement fund.
Major ways through that you can contribute to your Retirement Plan are:
1. Unit Linked Pension Plans (ULPP)
3. Systematic Investment Plans (SIP)
6. Provident Fund (PF)
In the next article we will discuss the feature, benefits, types and comparison of Unit Linked Pension Plans (ULPP) with other kinds of Pension Plans.