Savings objectives before reaching age of retirement

By Romesh Angunawela, Financial Advisor

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?

Retirement planning

Saving plans before retirement 

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 goal.

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 retirement