As millennials (those born after 1980) in India find it less likely to retire comfortably than their parents, the job of the financial adviser has become crucial.
A research by Willis Towers Watson on retirement planning in India indicates the proportion of workers who are beneficiaries of a formal retirement savings plan (via either the state or an employer) is relatively low. Most workers have to take care of retirement from their own savings.
Financial or retirement planning involves not only looking at current income and spending but also involves predicting them in the future, both in terms of timing (when) and their quantum (how much). The basic real life aspects that are key to modelling are:
- Current salary level and savings
- Current financial resources and change in financial resources in the future
- Growth opportunities in the future
- Life events in the future leading to a change in cash flows
- Time to retirement
- Inflation and annuity rates at retirement
Modelling (demonstrating) for all possible future scenarios is a daunting task as there are many types of cash outflows that need to be considered and mapped to possible sources of income.
Certainly, it would not be practical to assume that a regular income stream in the form of pension would be the only source of income. One cannot ignore other sources like interest income, rental income or dividends to name a few and also the level of return they will likely earn. Predicting post retirement living and medical expenses can be extremely uncertain, thus making modelling for the next 30 to 40 years even more challenging. Longevity, especially, is a risk that could grossly overestimate adequacy of post-retirement income if not factored into the model appropriately. A further challenge lies in converting the lump sum available on retirement to a regular income in the post retirement phase.
Various Willis Towers Watson studies indicate that retirement expectations are overly optimistic and are typically framed by current norms rather than a realistic assessment of what employees can expect on their retirement. Current expectations do not model the future scenarios adequately. Individuals do see rising cost of living as the most significant risk in terms of adequacy of retirement savings, while another potential risk factor is the contingency of emergency costs, cited by approximately two in five respondents in India. The question that arises is - how can these factors be modelled?
Two phases of retirement planning
There are two distinct phases of retirement planning and one needs to model them differently. The accumulation phase is one where the individual sets aside some money and lets it grow through investment returns. The longer the accumulation phase, the stronger the power of compounding and higher the flexibility that the individual has to invest in assets that can give higher expected returns (like equity). Then there is the de-accumulation phase where the accumulated corpus gets converted into an income for the individual.
Indians are culturally known to save more than their counterparts in the western world. Yet, confidence in the current level of savings for retirement reduces as one gets closer to retirement. The savings in India are largely invested in asset classes that are low risk and hence give low returns in the long run, or in asset classes like property or gold/silver.
Willis Towers Watson suggests advisers to look at retirement planning using advanced planning techniques that take inputs from the user by way of simple life event questions like:
- Likely age of marriage
- Likely break from service for self (or spouse)
- Current salary levels and savings
- Expected time to retirement
These parameters and other inputs (e.g. Inflation and income rates at retirement, medical inflation etc.) are based on the economic scenario at the time of modelling. With some additional questions on life events in the future, the model projects future cash flows including changes due to life events and helps you to draw their retirement plan.
In conclusion, most retirement planning is done based on current behaviour rather than a realistic assessment of what one can expect on retirement. Understanding the nuances of the accumulation and de-accumulation phases is equally important and one needs a balance between both.
Planning and modelling for retirement can be a challenge and one needs a holistic solution that looks at both accumulation and de-accumulation phases.
