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PROVIDENT FUND not enough for Retirement
While a large chunk of your retirement corpus can be funded by the Provident Fund, you may have to supplement it with other high-yielding options.
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 `5,000 a month and a matching contribution by his employer can build up a massive corpus of `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 `6.89 crore may appear huge, it may not be enough. If you need `50,000 a month for living expenses today, a 7% inflation would push up the requirement to roughly `5.34 lakh a month in 35 years. When you are 60, you would need a corpus of `10.52 crore to sustain inflation-adjusted withdrawals for the next 20 years. Assuming a post-tax return of 8.5% and 7% inflation, the `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. 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.
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.
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
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. 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
Ulips have earned a bad name because of the rampant mis-selling 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 `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 tax free on maturity.
Unit-linked pension plans
Unlike Ulips, unit-linked pension plans are not a very good option. Although they work like Ulips during the investment years, the rules at the time of maturity are different. You can withdraw only 33% of the corpus on maturity and the balance must compulsorily be used to buy an annuity. The pension from the annuity is fully taxable as income, so these plans are not tax-efficient. Besides, they have very high charges in the initial years, which eat into the returns of the inves tor. There is no online unit-linked pension plan on offer.
NPS
The New Pension Scheme offers greater flexibility to investors than the unit-linked pension plans from insurance companies. The charges are also very low. The investor can choose from six pension fund managers. He can also switch to another fund manager once in a year. The best part about the NPS is the life stage fund. Under this, the asset allocation is linked to the age of the investor. The exposure to a volatile class like equity is progressively brought down as the person gets older. "It is a well-planned pension product and facilitates automatic lifecycle-based investment option, making it attractive even for those who may not be financially savvy. The drawback of this scheme is that the equity exposure is capped at 50%, and 40% of the corpus must mandatorily be put into an annuity to earn a pension. As mentioned earlier, the pension income is fully taxable.
Traditional insurance policies
They offer tax-free income and insurance cover, but traditional insurance policies are not the best way to save for retirement. The returns are quite low at 6-7%, and the investor has very little flexibility. The PPF, which offers the same tax benefits, may seem like a better alternative. If the annual ceiling of `1.5 lakh in the PPF is a problem, you can contribute more to your PF through the Voluntary Provident Fund.
Apart from making additional investments for retirement, you need to plan for emergencies as well. An unexpected event can derail your financial planning. "Build a contingency fund for financial emergencies and buy adequate life and health insurance. The contingency fund should be big enough to take care of six months' expenses.
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