Savings objectives before reaching age of retirement
By Romesh Angunawela, Financial Advisor
(This is the third in a series of articles by the author on planning
Even as we looked into the demographical change,
which may cause concern to those who are to retire within the next 20 years,
it is always best to have a retirement plan that you have some control
on. Unfortunately, most pension plans in Sri Lanka do not offer sufficient
control in order to maximise benefits that the individual may receive at
retirement. The control aspect of a pension plan can
be illustrated, very well, through the deference in control that exists
between a savings account and the current pension plans available in Sri
Lanka (EPF, PSPF, WOF, etc.).
A savings plan allows you flexibility on the amount withdrawable, etc,
while there is a great deal of assumption involved in the current pension
plans. By maintaining such things as savings accounts a person has total
control over it and is aware of its performance and can easily determine
the kind of return that will be available at a certain point in time (e.g.
retirement, etc.). In contrast, most people do not have any idea as to
the amount of benefits they will be entitled to at retirement through their
current pension plans. However, it should be remembered that savings accounts
are not the best solution that one should adopt when planning for retirement,
though it may very well assist in building a part of the portfolio that
will be needed for retirement.
As you may agree there is a vast difference between a person wanting
to retire at age 60 with a monthly income of Rs 100,000 which will be generated
from his current investment strategy, to a person relying totally on a
government pension where the individual expects the government to pay pension
benefits of Rs 100,000 a month. While the current investment strategy can
guarantee some kind of certainty, the government pension is totally based
on assumption. Therefore, it is necessary to avoid benefits based on assumption
and put in place an investment strategy that can add a certain degree of
guarantee towards your retirement benefits. Planning early retirement is,
however, the best solution available in taking care of your retirement
needs. Most people postpone this commitment until they are close to retirement.
The gravity of postponing this crucial need is so evident on the life style
led by most retirees. If you believe that your children will look after
you at retirement, then it is well and good. However, will you children
have the necessary financial backing that they will need to support you,
taking into account their own commitments? (E.g. educating their children,
purchase of their own home, etc.) So, do you feel it is appropriate to
add additional pressure on you children?
As mentioned in my ear lier article, retirement planning has become a very
important part of an individual's overall financial plan. The primary objective
is to provide a sufficient monthly/annual income to provide you with a
life style that you desire at retirement. The rule of thumb in determining
the amount needed at retirement is 70% of your current income indexed properly
for inflation to take care of purchasing power. It should be stated that
58% of the Sri Lankan workforce is yet without any form of pension benefits
and those who are in some sort of pension plan are not adequately informed
as to the benefits they may receive at retirement.
Saving plans before retirement
The difference between after-tax income needed and anticipated after-tax
income available should be the savings objective for retirement. For example
if the after -tax income that is needed at retirement is Rs 100,000 but
the anticipated after-tax income is Rs 25,000 then your savings objective
for retirement should be to provide an after-tax income of Rs 75,000 per
a) After-tax income needed at retirement
The after-tax income at retirement should be equivalent to at least
70% of your current income and should be determined together with the life
style that you desire at retirement.
b) Anticipated after-tax income available
This segment represents all sources of income that will be available
to you at retirement. These may include business income, rental income,
investment income, pension benefits, etc. Anticipated after-tax income
helps minimise your monthly commitment towards your ultimate retirement
c) Savings objective for retirement
This is the difference between after-tax income needed and anticipated
after-tax income available at retirement.
If an individual's savings objective is to provide an after-tax income
of Rs. 75,000 (after-tax income needed Rs. 100,000 less anticipated after-tax
income Rs. 25,000) then the person needs to generate a fund of at least
Rs. 9,000,000 assuming a growth rate of 10 percent per annum (all figures
should be adequately indexed for inflation). The importance of planning
for retirement at an early stage helps minimise the monthly commitment
that an individual needs to set aside to meet his or her retirement goals.
Let's look into the following examples:
a) A person aged 30 years wants to retire at age 60 with a savings
objective of Rs 75,000 per month
* The amount of funds that need to be generated:
(Assuming a growth rate of 10% p.a.)- Rs 9,000,000
* The contribution term available:
(Retirement age 60 years less current age 30 years) -30 Years
* Monthly savings commitment- Rs. 9,000,000
30 x 12 = Rs 25,000
b) A person aged 50 years wants to retire at age 60 with a savings
objective of Rs.75,000 per month.
* The amount of fund that needs to be generated:
(Assuming a growth rate of 10% p.a) - Rs 9,000,000
* The contribution term available- 10 years
* Monthly savings commitment- Rs 75,000
The above examples clearly indicate the need to plan for retirement.
This, however, doesn't indicate that a person over 50 years cannot successfully
plan for retirement.
The principle behind achieving your retirement goal is based on discipline.
After you recognise your retirement goals it is crucial that you discipline
yourself to save on a regular basis. Though saving on a regular basis may
be difficult for some at the initial stage it will soon turn to be a habit.
Taking the time to prepare a family budget will help you determine the
amount of money available for savings. For example if your monthly earnings
amount to Rs. 100,000 and your expenses are at Rs. 70,000 you will have
to set aside Rs. 30,000 to meet your retirement goals. However, if you
can identify areas of unnecessary expense (entertainment, interest paid
on credit card usage and unnecessary tax payments due to improper tax planning)
this can help add up to your savings to meet your retirement goals.
It is best that you seek professional advice in order to structure a
proper financial plan, as this will ensure that you will have a comfortable