One should plan for all the known milestones in life. Retirement is one such crucial phase, and preparing for that phase is what is retirement planning.
A goal is to set suitable financial targets and create a plan to achieve those. In the process, you have to forecast savings, expenses and evaluate investment options after considering any potential financial risks.
The plan begins by determining the objectives, keeping an eye on the time left to retire. The idea is to save during the active life (years before retirement) and invest prudently to allow the corpus to serve you during the retirement phase.
Retirement planning involves considerable amounts of money. Therefore, it is an elaborate exercise.
The impact of taxes can be significant. Any unwarranted tax bill can significantly erase your wealth and derail the planned outcome. Hence, it is imperative to be tax efficient.
Similarly, an understanding of inflation, current and future interest rates, etc., is hugely beneficial. These aspects may sound familiar and arguably trivial. However, even a marginal change in these assumptions can meaningfully affect the plan.
What is retirement planning?
Retirement planning is to prepare for the phase of life that exists beyond the earning years.
The retirement plan is about financial aspects, but it often includes non-financial facets such as lifestyle, place to settle, family status, insurance coverage etc. A well thought out retirement plan considers all possible financial and non-financial factors.
The amount of emphasis on retirement planning is different through different phases of life. A general expectation would be to focus on retirement only closer to the years you are about to retire. However, there is merit in reconsidering the strategy and start to plan for retirement from an early age.
Do read on how to plan for retirement at an early age.
Why make a retirement plan?
Live life as it comes. Live each day. Then why plan for retirement at all? These pieces of advice sound bold, but one should not practice them in life when it comes to financial or retirement planning.
Here are some points to consider why to make a retirement plan:
- You will not work forever, and hence, the active income will stop. You must have enough funds to be able to maintain your lifestyle post-retirement
- Life expectancy is increasing, so you need more money to be able to last longer
- Saving money is possible only when you are earning
- Life is not always straightforward, there can be emergencies, and some may severely impact pocket
- Retirement is the golden era of life, and you want the best out of those years
- Interest rates are coming down. To rely on just the interest income can be risky
- Living with children should be an option and not the only option – a financially secure retired life will provide you with the independence you deserve
- Contribute to society and support the cause you believe in
- Be the one in the family who is always available to help, emotionally, physically and most importantly, financially
- Be able to leave behind a legacy
To lead a peaceful and uncompromised life post-retirement, you must plan ahead of time. Firstly, plans do not appreciate known surprises and the arrival of retirement moment is never unannounced. One must plan for it. Secondly, a sound plan must forecast all possible instances and requirements. Thirdly, one must prepare for emergencies as life is unpredictable. And finally, if you do not have money when you need it, there is no point in having that money at all.
What are the three stages of retirement planning?
The easiest way to split the retirement planning is to divide it into phases based on age. The primary focus of each stage is different, and hence there is merit in understanding each.
Young age (age up to 35)
At this age, the disposable income is low, and so are the commitments. The living expenses are limited, and the savings potential (savings as % of inflows) is reasonable to high.
The most significant advantage to start at a young age is the availability of time. You have ample time to invest and let the money grow and compound. Also, early beginners have sufficient time to course-correct any unplanned portfolio changes or change in circumstances.
Read here about the power of compounding to know more about this concept.
Middle life (age up to 50)
During this time, the family and financial profile of a person has changed significantly. Expansion of family could have led to incremental financial commitments and stress. Expenses like mortgages, insurance premiums, child education expenses, medical expenses for ageing parents, etc., are most common.
The income has also expanded, along with the outflows. The scope to direct any additional sums to retirement funds is often limited. However, it is inherently important that you continue to maintain the retirement contributions. Do not disturb the existing investment plan, unless for better.
Later mid-life (age up to the retirement)
The investment strategy is more conservative now. The retirement corpus gets invested into certain asset classes, which are safe and less volatile.
For some of you, this is the age where you have peaked in your work (whether salaried or entrepreneur). The inflows are solid. Some of the outflows do not exist anymore, e.g., mortgages, child education expenses, etc. The disposable income is significantly high.
It’s the right time for you to make good any shortfall and catch up with the contributions to the retirement corpus. You may also want to reconsider the retirement corpus looking at the elevated lifestyle. Any such decision is time-based and depends on the situation then.
What happens if I am late to plan for retirement?
To start late will have repercussions. Of course, there are chances you may still be able to catch up. But, all are not as lucky to catch up entirely and do as better as they would have done if they started early. Here are a few drawbacks to start late:
- Compromise lifestyle post-retirement
- Make riskier investments, risking the capital
- Contribute considerably higher sum towards corpus but putting a cut on expenses during the years immediately preceding retirement
- May not be able to create a dependable secondary source of income
- Let go of a few wish-list objectives
Having said the above, not planning for retirement is not the right strategy. Thus, start as soon as you can.
A step-by-step approach to retirement planning
The importance of retirement planning is a given. Here is a step-by-step approach to guide through the process of how to plan for retirement:
Evaluate the available time horizon
As a start point, determine the available active earning years. The process is simple for salaried folks, where the retirement date is prescribed. Self-employed people must boil down to age until when they think they can work full steam. The next step is to gauge the years’ post-retirement, which is the life expectancy. One can’t forecast life so we should assume the average life. The life expectancy will be different based on your circumstances, but any reasonable assumption is acceptable.
Establish the risk tolerance level
It means you must know the amount of risk you can take. Your financial and family background, i.e., the assets you own, liabilities you have, number of dependents etc., play a significant role. Further, the more the number of years to plan for retirement, the higher the risk tolerance. And vice versa.
Determine living expenses
The next step is to find out the household expenses. The nature of costs will change as one transition from the active life phase to the retirement phase. However, the quantum may not necessarily change significantly though.
Forecast medical outflows
Generally speaking, such expenses form part of routine living expenses. However, please put a particular focus on planning for these expenses. Life expectancy is on the increase, given the technological advancements. Consequently, outlays on medical needs are on a constant rise. Medical expenses can be significant in some cases and hence requires proper attention. Also, do ensure that you have subscribed to a ‘medical insurance‘
Calculate the corpus
Based on the living expenses, compute the target corpus required to meet those expenses. Give due consideration to the state of inflation, long-term expected rate of return (directionally, you will have a sense), tax rates, etc.
Make an investment plan
To identify future living expenses is the first crucial milestone. However, the immediate next step is even more critical. You have to save the right quantum and invest the money to accumulate the desired corpus. A well-crafted investment strategy and timely assessment of the progress is also necessary to meet the financial target.
Create an emergency corpus
One must expect the unexpected. We recommend creating an emergency corpus equal to 12-18 months of living expenses to deal with contingencies. Keep this fund outside the scope and, over and above, the retirement planning exercise.
Read more about retirement planning here.
Importance of retirement planning – the bottom line
The retirement phase of life is inevitable and will come for one and all. The best approach to welcome those golden years is to plan and embrace the change in life.
Be financially prepared to relax and spend time with family & friends. Pursue a hobby, contribute to a social cause, and do what you always wanted to do.
Avoid making mistakes like withdrawing retirement funds early. Do not contemplate too much or delay on critical aspects like term insurance, medical insurance, etc. Diversify your investments based on age and risk profile, do not skew them towards a specific asset class. And lastly, evaluate your investment options as all that glitters is not gold.
Be committed to the retirement plan. Be meticulous from the inception and let the portfolio outlive your life. Leave a legacy.
The best retirement plan is to plan for retirement.
Start early and invest consistently. Remain invested and believe in your strategy. Happy retirement planning!
About the author
The author is a senior finance professional with over fifteen years of work experience in corporate finance. He has an affinity for matters relating to personal finance and investment management. Through his writing, the author wants to share his knowledge and understanding of the subject.
The author has used his knowledge, experience, and understanding of the subject and has exercised extreme care and caution to avoid any possible mistakes. However, the author does not take any responsibility for any error that exists.
Any views, opinions, and thoughts mentioned in the article belong solely to the author and not necessarily to the author’s employer (past or current), organization, committee, or other group or individual.
Under any circumstances, the author shall not be liable for any views or analysis expressed in this note. Further, the opinions expressed are not binding on any authority or Court. We advise readers to consult their financial advisor for assistance in their specific case.