They should have some exposure to equities to counter the risk posed by inflation
Retirees face a big challenge in making their corpus last 25 years, with regular cash flows from salaries drying up, increase in life spans, and health care and other expenses going up.
On the occasion of Global Parents’ Day (July 24), we offer a few tips to those who retired recently on how they should manage finances.
Retirees get a considerable sum from the Employees’ Provident Fund and gratuity at retirement.
Many gift a considerable portion of this to their children.
Anil Rego, chief executive officer of Rght Horizons, says by giving away the money early, retirees face the risk of the remaining amount running out, given inflation. He says money should only be passed on through a will.
Many retirees also invest excessively in fixed-income instruments. Says Ankur Kapur, founder, Ankur Kapur Advisory: “Provided you are comfortable in assuming risk, you should have some allocation to equity.
"This will help counter the impact of inflation in the long term.”
There also many who have a significant part of their wealth tied up in residential real estate, where rental yields are barely two-three per cent.
“Since they need to generate higher cash flows, retirees should evaluate whether they need to sell off the house and reinvest in financial instruments,” says Vishal Dhawan, chief financial planner, Plan Ahead Wealth Advisors.
An apartment is an illiquid asset as it cannot be sold at short notice in case of an emergency.
Retirees must also try and purchase a senior citizens’ policy, despite steep premiums.
“Look at the exclusions, waiting period for pre-existing diseases, and the co-payment clause when buying this product,” says Rego.
They need to make changes to their portfolios. First, they must divide expenses into fixed and discretionary categories. They should use fixed-income instruments to meet fixed expenses.
They should also minimise tax liability by generating only as much income as they need, and the rest can be invested in equities.
Some fixed-income instruments they can look at are Senior Citizens Savings Scheme, Post Office Monthly Income Scheme, bank and corporate fixed deposits, debt mutual funds, etc. SCSS, which pays a high interest rate of 8.6 per cent, and POMIS, which pays 7.8 per cent, can be used to generate regular income.
Once the income comes into the taxable bracket, they should use more tax-efficient instruments like debt mutual funds, specifically short-term debt funds.
The systematic withdrawal plan option should be used after three years.
Alternatively, money should be shift from equities to debt funds three years before retirement to be able to use the SWP option right away.
Retirees must also pay attention to liquidity when choosing fixed-income products.
Only those with a large corpus should invest in immediate annuities, where access to the principal is limited. The advantage of annuities is that they offer a fixed rate of return for a lifetime and are not subject to reinvestment risk. Depending on the person’s age, an annuity could give a return of 6-7.5 per cent.
When investing in fixed deposits, they must use two-in-one bank accounts from which money can be withdrawn easily.
They should not just go by the rate of interest, and must make sure the bank is stable.
“Ladder FDs so they mature at different points of time to counter reinvestment risk,” says Dhawan.
Those who have more funds to spare for five years or more, should allocate more to equities.
They should use diversified-equity funds like large-cap and multi-cap funds to invest in equities.
They should take the SIP or systematic transfer plan route, and not the lump sum option, to invest in them.
SMART MONEY TIPS FOR RETIREES
- Avoid gifting a part of your retirement corpus to children upon retirement. Pass on wealth only via a will
- If a significant part of your wealth is tied up in real estate, evaluate whether you need to liquidate this asset to generate more cash flow
- Generate only as much income from your retirement corpus as you need, so that your tax liability is minimum
- Use systematic withdrawal plans of short-debt funds to reduce tax liability
- Have some exposure to equities for countering the impact of inflation on purchasing power
Image: Suresh Chitre, 67, and his wife Rekha Chitre, 63, stand on the balcony of their flat at the Athashri retirement village in Baner, on the outskirts of Pune. Photograph: Danish Siddiqui/Reuters