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Why and how to hide your retirement money

 

While there are some people who never want to retire, and some who want to retire early, most people aim to retire between 60 and 65 years of age when they no longer have the energy for full-time work.

Yet the average life expectancy is going up. In India, men are expected to live to 67 and women to about 70 years, while in developed markets like Japan, Singapore and Australia, life expectancy is already 80 for men and 85-87 for women.

If these statistics don’t scare you, consider this: not only will you not have a regular income during retirement, but you’re likely to have higher medical expenses.

Add to that the fact that retirement is the only significant financial goal you can’t get a loan for. You can get a loan for buying a car, home, kids’ education, even holidays. But all of these rely on your ability to repay the loan while earning an income. Since you won’t have that, you won’t be able to borrow (other than perhaps a reverse mortgage).

At this point, most Indians I know assure me their children will look after them. I wish them well, but the risk manager in me wants to ask, “What if they can’t for some reason?”

So what’s the solution?

Delay gratification

When we earn well, it’s natural to want to live a good life. But you need to delay gratification today to be able to live decently later. It’s like squirrels, who store nuts away for winter when they know it’s too cold for them to go out.

Some of us are able to do this easily, whether by birth or early conditioning, while others struggle. But research shows it’s a habit worth cultivating.

The Stanford marshmallow experiment was a series of studies in the late 1960s and early 70s on delayed gratification, led by psychologist Walter Mischel, then a professor at Stanford University. In these studies, a child was offered a choice between one small reward provided immediately, or two small rewards (i.e., a larger reward) if they waited approximately 15 minutes, during which the tester left the room and then returned.

In follow-up studies, the researchers found that children who were able to wait longer for the preferred rewards tended to have better life outcomes, as measured by SAT scores, educational attainment, body mass index and other indicators.

The problem is that not all of us have the self-control or self-motivation to delay gratification. If we did, there wouldn’t be so many wasted gym memberships.

Lock it up for tax benefits

In more developed markets, people didn’t have to think about retirement too much. They worked for large corporations and governments for decades and retired with a ‘defined benefit’ pension, linked to their last salary, for the rest of their lives.

People who didn’t get a pension from their employer got one from the government as an old age pension, a form of tax-funded social security. But in recent times, governments have realised they got their math wrong – they have overpromised and can’t really deliver. So they’re slowly encouraging people to take responsibility for their own retirement using tax incentives (carrot) and compulsory preserved savings (stick).

While India doesn’t have a social security system for ordinary citizens, it does recognize the problem, one of many that can snowball into social unrest. So, like many other countries, it’s trying to develop a pension fund to help you save for your retirement.
Here is a summary of Indian pension funds that offer tax benefits in exchange for locking up your money, or hiding your savings from yourself:

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In addition to pension funds offered by the government, private insurers and mutual funds also offer retirement products. There may also be tax deductions in return for locking up your money. The main difference between government and private companies is that the latter can invest in a wider range of instruments, albeit at a much higher cost.

Having been involved in the launch and implementation of the NPS, I can say the pension ecosystem in India is still relatively nascent. The current debate around taxation and preservation is an example of this. Hence, it’s wise to diversify your retirement savings basket beyond these government pension funds, into other non-preserved financial instruments such as mutual funds, as well as physical assets such as real estate and gold.

…or higher returns

If you can’t get tax benefits, it’s worth looking at other ways to boost the returns on your savings. You could try investing in riskier or leveraged investments, or putting your money in longer-term investments.

Since your retirement could be decades away, you can invest in equities, which can be volatile in the short term but tend to provide higher returns than fixed income in the long term. This is because equities represent shares in real productive businesses. The benefits of higher returns over a long-term horizon are even greater due to the effect of compounding.

You can combine equity investing and tax incentives, both in a pension fund environment (such as the NPS) and outside (through equity-linked saving schemes, simple equity mutual funds or direct shares). Indeed, that’s what I’ve done with my pension fund.

Retirement saving is a tricky topic to cover in a short blog. I’ve tried to explain why you need to save and that you may need to hide these savings from yourself. You can do so by investing in pension funds where the government gives you tax incentives in exchange for locking the money up, or by investing in equity funds where you will experience volatility but do better in the long run.

 

Hansi Mehrotra, CFA is a financial educator who writes and speaks on various platforms, getting named as a ‘Top Voice for Money and Finance’ on LinkedIn for 2015. Hansi has more than 20 years experience in financial services.

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