Personal Finance – Page 3

Download Excel Based Retirement Calculator

Reader Pattu Â has developed a retirement calculator for his own use, and was interested in sharing it with other OneMint readers as well. I took a look at it, and liked what he’s done, so I’m sharing the calculator here.

Download Retirement Planner

He has also described his thought process, which I’m sharing below.

Retirement planning is a complicated financial goal. When you save for a new car, exotic holiday or even for the education of your children, all or most of the accumulated corpus would get spent when the time for the goal arrives. So it is easier to calculate the corpus required for such goals.

When it comes to retirement planning the corpus calculation is complicated because the corpus does not get spent in one shot. Typically it is allowed to grow at some post-retirement interest rate (usually underestimated for safety) and monthly withdrawals are made from it. For complete financial independence during retirement, these withdrawals or pension must increase according to the post-retirement inflation rate.

So the retirement corpus calculation has to take into account not only the years to retirement, present inflation rate but also post-retirement inflation, number of years in retirement and post-retirement interest rate on the corpus.

Given these input parameters, retirement planning consists of two major steps.

1. Calculation of the corpus required:

(a) Compute projected future monthly expenses at the start of retirement. This amount can be taken as the initial monthly pension which will be withdrawn from the corpus.

(b) This monthly pension amount is assumed to increase every year according to the rate of inflation, while the corpus is assumed to grow at some constant interest rate. Using these inputs the corpus is calculated using Excel’s present value calculator (PV).Â The inputs to the PV function, the formulae used are a bit technical and can be found here.

(The site also has a nice annuity calculator which will be of interest to people close to retirement).

Since the withdrawals are indexed to inflation, the corpus will decrease each year and become zero at the end of the retirement period given as input. A typical rise and fall of the corpus is shown here.

2. Calculation of the monthly investment amount required:

Once the corpus needed is known this calculation is similar to any other financial goal. It uses the number of years to retirement, estimates of present inflation and annual interest rate, annual increase in investment if any, and amount accumulated so far if any.

The excel based calculator does the above tasks and present an annual cash flow chart of the monthly investment made, monthly expenses, the growth of the retirement corpus prior to retirement and its decrease post retirement. Annual salary is also shown for reference.

Please note:

1. The calculator has been repeatedly tested and checked. However no guarantee is made that it is free of errors. Like every other tool it serves only as an estimate for the monthly investment required and depends on the input parameters. It is meant to be used for education purposes only.

2. For simplicity the pre- and post-retirement inflation rates are taken to be the same. Use a reasonably high value to be safe. A financial expert suggested using 8-9%

3. The pre-retirement interest rate is taken as constant. Since equity allocation would decrease as retirement approaches this would change. The calculator can easily be modified to take into account variable interest rate. Contact me if you need to look at such a calculation.

Download Retirement Planner

Bugs, comments and suggestions are welcome.

Pattu

pattu@iitm.ac.in

Update: Fixed a divide by zero error bug.

How much pension will I get from the NPS?

A question that pops up quite frequently in comments is how much pension will I get from NPS, and I think it’s not clear to a lot of people that the NPS itself won’t give them a pension.

There are two things that you need to keep in mind:

NPS doesn’t pay a pension directly.
There is no fixed rate at which your money will grow.

NPS doesn’t pay a pension directly

The way NPS works is that you invest regularly in the scheme and the scheme invests that money on your behalf.

At the age of 60 you will get the money and it will be up to you to invest it and generate an income for yourself. In this regard you can think of it more like a provident fund than a pension.

Under NPS there is no fixed rate at which your money will grow

When you open the NPS account – you will be asked to select a fund manager and your money will be invested by this fund manager. You will also be asked whether you want to choose an Ultra Safe, Safe or Medium approach, and based on your selection the fund managers will spread your money between debt and equity instruments. The rate of growth will depend on the performance of the fund managers and the choices you make, so to that extent it’s not like a bank fixed deposit where they tell you that you will get 8 or 9% interest regardless of anything else.

How to calculate pension amount from NPS?

Keeping these things in mind it should become clear that you can only get an idea of how much pension you can generate and not an accurate answer.

So, how do you get that idea?

Suppose you have the following question:

I am 28 years old – how much pension will I get if I invest Rs. 2,000 every month?

CAMS has got this great corpus calculator which allows you to input the parameters and tells you how much your final corpus will be.

In this case I’ll put in the following numbers:

Contribution Amount: 2000
Periodicity: Monthly
Rate of Interest: 9.5% (Assumed)
Number of Years: 32 (60 – 28)

The calculator shows me a value of Rs. 50,05,164.

Now, this is the amount that you will get at the end of 60 years, and you will have to invest it in order to get a pension. You could create a bank fixed deposit with it or buy an annuity. NPS requiresÂ you to buy an annuity from 40% of your money in the Tier 1 account compulsorily, but there is no such restriction on the Tier 2 account, so you can keep that in mind while opening the NPS account.

Conclusion

The first thing you should keep in mind is that NPS won’t pay you a pension directly, the second point is that the rate of return is not fixed either, and the third thing is when you get the NPS money you will be free (to an extent) to invest it, and generate an income for you as you see fit.

Your salary will increase with inflation too

I got this email early last week (slightly edited):

I would like to know something about annuity. I am 49 yrs old, suppose I am investing Rs. 100,000 yearly till i attain 60 years and NPS is showing growth in total of 1600000.
40% will be 6,40,000.
Now explain to me how annuity of 6,40,000 will help me for rest of my life?/for how long?/how much?
I am still confuse about retirement plan.
If I calculate inflation and I retired at the age of 60 yrs and live up to 75 years. What so ever I save for my retirement plan appears to be peanuts.
Thinking daily on “life after retirement” a am spoiling my today.
If you have some better idea about retirement please guide me.

To me the heart of the problem is the sum that this person expects to accumulate when he is 60, and not the annuity itself because if you can accumulate a decent sum at the time of retirement, then you can do an annuity, fixed deposit, plan your withdrawal rate, whatever, but if you don’t have a lot at that age, then what is the point of thinking about anything else?
In that sense, I think this is slightly different from the earlier discussions we’ve had on this topic here.

In an economy like India where the inflation rate is quite high it is only reasonable to be worried about how inflation will eat into your retirement nest, however the other side of the coin is rarely talked about, if ever at all.

Your salary should also increase to match inflation and you should at least be able to increase your savings by the inflation rate or even if it is a smaller number, there should be some increase right? But this is too often not accounted for even when it’s quite clear that it can be quite a big number.

Let me give you an example: If you invest Rs. 1,00,000 per year for 12 years, and get 8% per annum returns on your investment, at the end of the 12 years you will have a corpus of Rs. 18,97,712, but if you increase your investment by 8% every year by age 60 you will accumulate about Rs. 25 lakhs, and one more year will make this sum go to Rs. 30 lakhs.

I’ve done these calculations here so you can see how I reached that number.

The key is not to be despondent, and start doing the right thing – better late than never right?

Poll results: How much money do you need per month to retire in India today?

In the last poll I had asked you how much money do you need per month to retire in India today, and 48% of you (190 votes) said between Rs. 20,000 and Rs. 50,000. To my surprise, the next biggest segment was the more than Rs.1,00,000 segment with 20%, and you can see the rest of the results below.

(click for bigger image)

In this post, I am going to be what I think is called a party pooper, and say that a lot of you believe that you’ll need lesser money than you spend today during your retirement, but you are probably wrong.

For starters, if you’re salaried and not in your forties yet, then you are probably far away from what is going to be your peak income. Your income might look like a reasonable sum to you today, but wait till you start making a lot more, and see Parkinson’s second law kick into effect:

expenditures rise to meet income

Now it’s true that you will have more responsibilities at that time than today, and a lot of those will not be present during your retirement, but it’s just as likely that there are some unforeseen liabilities as well; how is that percentage going to work out? How do you calculate something like that anyway?

Next up, when you think that you will need lesser money during retirement than today, that automatically implies that you need to save less today, and that in turn implies more money to splurge; think about it – aren’t you much more likely to lull yourself into making some assumptions that make spending easier today? After all, delayed gratification is hard, really hard.

That said, I believe that a lot of you are way ahead of the game just by thinking about retirement, and planning for retirement. Starting retirement planning early means that you develop a long term approach to retirement, think about various alternatives where you can invest your money, not fall in credit card debt, and give yourself the benefit of compounding which makes a huge difference.

As long as you are not looking at huge debt, saving a decent amount by being frugal (but not stingy), and making good investment habits, whatever your number is – you will be alright.

So don’t fret too much about the number, which is too far out in the future, and so variable that it’s hard to predict, and focus instead on developing good financial habits. And thank you all for your wonderful comments!

A primer on the New Pension Scheme (NPS)

Iâ€™ve wanted to write about the New Pension Scheme (NPS) a lot sooner, but never got around to it. Reader Gaurav sent me some great material on it, and got me started.

The stuff that he sent me was an entire post in itself, but I thought Iâ€™d add to it, and create a comprehensive post on the New Pension Scheme.

First off, you can call it New Pension Scheme, National Pension System, New Pension System or NPS, anything you like. Theyâ€™re all the same; Iâ€™ve seen different articles call them different names, so that might get a bit confusing, but youâ€™ll soon get used to it.

Next up, some of the things this post will address, are:

What is the New Pension Scheme?
What are Tier I and Tier II accounts in the NPS?
What are the three categories in the NPS?
Fees and Expenses related to the NPS?
What is the minimum amount needed to invest in the NPS?
What are the tax implications of NPS?
How can I open a NPS account?
Why hasnâ€™t this become popular?

What is the New Pension Scheme?

The NPS was introduced by the government last year to give people a way to get a pension during their old age. Employees of the government sector already get a pension, so this scheme was introduced as a social security measure that enables people from the unorganized sector to draw a pension as well.

The working mechanism is quite simple – you contribute a certain sum every month during your working years, which is then invested according to your preference. You can then withdraw the money when you retire, which is currently set at 60 years old.

When I say you invest according to your preference, I mean that there are a couple of different options that you need to select from. These options pertain to your preference on withdrawal, and asset allocation.

What are Tier I and Tier II accounts in the NPS?

The NPS is meant to be a pension scheme, so it is geared towards giving you a steady stream of income on your retirement.

That means that NPS makes it difficult to withdraw your money during your working years or till the age of 60 in this case.

Tier I and Tier II are two options under the scheme where you can invest your money, the primary difference between them is how they differ in allowing you to withdraw your money before retirement.

NPS Tier I

There is severe restriction on withdrawing your money before the age of 60, because it is necessary to invest 80% of your money in an annuity with Insurance Regulatory Development Authority (IRDA) if you withdraw before 60. You can keep the remaining 20% with you.

When you attain the age of 60, you have to invest at least 40% in an annuity with IRDA; the remaining can be withdrawn in lump-sum or in a phased manner.

Here are the details of how your money can be withdrawn in a NPS Tier I account.

Death is another way of getting the money, but that might come in the way of other plans you have.

NPS Tier II Account

The first thing about the NPS Tier II account is that you need to have a Tier I account in order to open a Tier II account.

The Tier II account makes it easy for you to withdraw your money before retirement because there is no limit on the withdrawals you can make from the Tier II account.

You need to maintain a minimum balance of Rs. 2,000, and you can transfer money from the Tier II account to Tier I account, but not the other way around.

There is a Rs. 350 CRA (Credit Record Keeping Agency) charge which is not present in the Tier II account, but the rest of the fees remain the same.

Asset Allocation and Categories in the NPS

There is an Active Choice option, and an Auto Choice option. If you select Auto Choice then your money is invested in a certain percentage in the various classes based on your age.

Here are the three investment classes:

Class	Risk Profile	Description
G	Ultra Safe	Will only invest in Central and State government bonds.
C	Safe	Fixed income securities of entities other than the government
E	Medium	Investment in equity related products like index funds that replicate the Sensex. However, equity investment will be restricted to 50% of the portfolio.

In the Active Choice you can select how much of your money will be invested in the different classes with a cap of 50% in Class E.

Now, there are pension funds that will manage your money, and in either of these options you have to select the fund manager who will manage your fund. So even if you select the Auto Choice, you still have to tell them which fund manager you want to manage your money.

Fees and Costs related to the NPS

I talk about expenses a lot here, and the expenses on the NPS are really low. The annual fund management charge is 0.0009%, which is probably the lowest in the world.

There are some other expenses associated with the NPS, but as you will see all of them are quite low as well. Here is a list of the other expenses.

What is the minimum amount needed to invest in the NPS?

For a Tier I NPS account you need to contribute a minimum of Rs. 6,000 per year, and make at least 4 contributions in a year. The minimum amount per contribution can be Rs. 500.

Minimum amount for opening Tier II account is Rs. 1,000, minimum balance at the end of a year is Rs. 2,000, and you need to make at least 4 contributions in a year.

What are the tax implications of NPS?

The revised Direct Tax Code proposes to make the NPS tax exempt at the time of withdrawal. Initially NPS was going to be taxed at the time of withdrawal, and that had put it at a disadvantage to other products like ULIPs and Mutual Funds. But the revised code proposes it to be exempt from tax, and that really adds to its lure.

How can I open a NPS account?

You can open a NPS account by going to the bank branches of the banks that are authorized to sell this.

Conclusion

This is quite a good option for people who wish to invest for their retirement, and the government has done good to come up with such an option. It is still early days for the scheme so there are going to be some teething troubles, and I am sure you have come across several articles that write the NPS off completely, or suggest major changes.

While it has not gained in popularity the way you wouldâ€™ve expected with the low cost structure, a primary reason of that is there is no real incentive for anyone to push this to consumers, so it has not gained any real traction.

That being said, the scheme is a good initiative, and given enough time, the chinks should be ironed out in its favor.

As a final word – a big thank you to Gaurav who sent me all the material, and pushed me to write about the NPS. Thanks Gaurav!

New Poll: How much money do you need per month to retire in India?

When I wrote my post about how much money do you need to retire, I focused on the number that you will need at the time of retirement, and how to get to that number by starting off on your investment today.

I see that a lot of people reach that page looking for information on how much they need today, not necessarily thinking about the future.

At some level it makes sense because that is really the starting point in your calculation. You see where you stand today, how much you need today, and then make certain calls about how your retirement lifestyle will be, and extrapolate your needs for then.

Personally, I think that this question is best answered by each individual himself, but that doesn’t mean there aren’t general guidelines and pointers that help frame the answer.

With these thoughts, I start off on my new poll: How much money do you need per month to retire in India today?

a) Less than Rs.20,000

b) 20,000 – 50,000

c) 50,000 – 1,00,000

d) More than 1,00,000

All of you have different assumptions, life-styles, needs etc. and that might give a lot of variation to the answers, but we won’t know if we don’t poll!

Please leave your comments about your thoughts on this question, and vote using the poll options on the left sidebar just above the “Recent Posts”.Readers getting this in email will have to click through the link and reach the website first.

Hoping to see some great comments like last time.

Things to do before you retire

Authors Bio – Today Marie Nelson will be writing a post for us. Marie is passionate about personal finance, and is going to share a retirement related post with us.

Life has been divided into 3 stages and the last stage is retirement. A new lifestyle waits post retirement. This transition would not only affect you but also have a remarkable impact on the people associated with you. If you are not prepared for retirement then it might affect you and your family adversely. But this article would share few tips that would help you have a post retirement life without any financial hardship.

Before you retire keep the following thing in mind:

1)Â Â Prepare a post retirement budget:

Other than your professional work clothes or transportation to the office your other expenses would remain same. But your income might be less than before so it would be advisable to prepare a budget plan according to your standard of living. Your expenses would not go down post retirement so maintaining a budget would save you from incurring debt. So plan your future that it does not take a toll on your pocket.

2)Â Â Observe your cash flow:

There are several sources for the retirees to draw their income for instance Social Security, pensions, investments and, increasingly, part-time jobs. Before you retire you need to scrutinize your source of income so that you can avoid financial doldrums and can pave a smooth post retirement life. Ensure you have source to pay all of your monthly bills. Retirement income such as home equity, annuities, insurance, royalties and rental income are not that popular among the retirees.

3) Reduce your taxes:

When you put your money in retirement investment plans like 401k and traditional IRAs it is not considered taxable income till the cash is withdrawn. As tax bracket fluctuates year after year so in order to minimize taxes withdraw the cash after you have researched on the market. When you find tax brackets are lower than either you withdraw it or it to a Roth IRA plan. And when the tax bracket is higher on the graph then withdraw a fraction of the amount.

4) Increase Social Security:

Retirees should sign up for Social Security before they retire in order to secure their future. As a certain percentage of your paycheck is directly deposited into the social security fund you can easily reap the benefit from it. Try to avoid claiming it before you turn 70 years as the payments is increasing per annum. Higher return can be expected if you delay your claim it would save you from the financial crisis at the time of your old age.

5) Plan for a long term goal:

Retirees need to do a long-term planning as they might not have any other source of income and they might come across uncertain emergencies. Medicare pays for nursing up to 100days but if you are struck by some chronic disease then you might require longer period of time to cure. In this case hefty amount of cash would be drained out from your savings account making you penny less. Look for a long-term-care insurance policy in order to protect yourself from high chronic care costs.

6) Maintain the emergency fund:

Maintaining an emergency fund is crucial at any stage of your life. This is because you never know when you require cash to mend the leaky roofs, repair the cars, and other large uncertain expenses. Make sure that you keep the emergency fund in FDIC-insured account or invest it in some profitable fund. FDIC insured account would allow you to delay withdrawal from investment accounts when the stock market would be down.

7) Existing debts needs to be paid off:

Before you retire make sure to pay off your entire debts. As these are liabilities and you would never want to carry the burden of debt post retirement. Calculate the total amount of debt you owe and then start paying the debt with high interest rate. By the time you retire you can unshackle yourself from the clutches of debt.

8 ) Synchronize with your spouse:

Retirement would bring a new change in your life and this change might have an impact on your marital relationship. One of the spouses decides to retire then the other spouse may continue with his job. You can divide the financial responsibilities if both of retire together. In this way you can achieve financially secured future even after your retirement.

How much money do you need to retire?

Reader Gaurav wrote in some time ago with a question about retirement investment options and plans, and I have been thinking about them for some time now. But every time I think about investment options, my mind wanders to the question of how much do you really need to retire?

To answer that you need to think about the following questions:

1. How much money will you spend per annum ?

2. How many years do you have till retirement?

3. Number of years you need the money after retirement.

4. Annual Inflation

5. Expected return

Take a look at this Retirement Calculator from Bank Rate. It lets you plug in the numbers, and tells you how much money you will need at the time of retirement to last the rest of your life.

It also tells you how much money you need to invest today to get to that number on your retirement age.

I suggest you play with this calculator alone because you donâ€™t want people hear you yelling obscenities when this thing throws up the number you need today (not that it happened with me).

But I am not really interested in the number that I need today – I am interested in the number that I need when I retire, so my next instinct was to try and plug these numbers into a Systematic Investment Plan calculator to see how much money I need to invest per month to get to the final amount at my retirement age.

Now, the thing with this is that you need a SIP calculator that allows you to increase contributions every year because you are on a really long time horizon, and if you say you are going to invest 15,000 every month – that might be big now, but in 15 years time, it will probably just buy you a movie and popcorn.

Use this increasing SIP calculator toÂ plug in the numbers and find out how much you need to save today to get enough for your final retirement plan.

Using this calculator brought me close to a reasonable but significant number, and I must say this has been a really good exercise for me to see how much I need for retirement, and then back calculate to see what I have today. The numbers seem a bit daunting today, but I am much better off because now I am not shooting in the dark, and have some sense of what I am looking at.

Play with the calculators, and be careful about your assumptions, that will make a lot of difference. Hopefully you will come up with a number that will be the beginning of a solid retirement plan.

Interest rate on your savings account may go up

A few months ago RBI mandated that all banks pay a interest rate of 3.5% on daily balance of savings accounts.

That was a very good change for customers, as the old way of calculating interest was unfair on them.

In the old way – banks used to take the minimum balance of your account between the 10th and last day of the month, and calculated interest on that. So, if you had a low balance on one day but a decent amount for the rest of the month â€“ your interest would still be calculated based on the lowest balance.

Example: You have 40,000 from Feb 1st to 25th, but on the 26th, you pay off your car and housing loan EMI, due to which your balance comes down to just 5,000.

The bank will pay you interest for the whole month of February only on Rs. 5,000.

After the change – banks calculate interest on daily balances, and pay you interest according to what you have in your account every day.

Now RBI is thinking about another change that can benefit savers. It is mulling deregulation of interest rates on savings bank accounts.

Currently, RBI mandates that every bank pay an interest rate of 3.5% on savings accounts. But it is contemplating de-regulation, and may allow banks to set their own interest rates.

This will mean that banks have freedom to set interest rates and will compete with each other for saverâ€™s funds.

There will be several implications of this, and let me pen down a few here:

1. Differences in interest rates will exist: It is quite likely that after these changes, some banks increase the interest rate by a percent or so to gain new accounts. At the same time, some other banks that donâ€™t need so much liquidity or provide other value added services may reduce the interest rates. (I realize this is a duh point, but needs to be stated nevertheless).

2. Hit bank margins: According to this NDTV article, State Bank of Hyderabad (SBH)Managing Director says that the bankâ€™s net interest margins will be hit. This is a clear sign that she expects the interest rates to go up once the deregulation takes place.

3. Customers will go rate-shopping: Not all customers will bother about a extra percent or so, but there will be a segment that has an eye on increasing interest rates and will move their money from one bank to another based on interest rates.

4. Banks will introduce teaser rates and confusing schemes: Banks will become innovative and introduce rates that are valid only for a few months or weeks, and then adjust downwards. As time goes by, they will get more and more innovative and the schemes will become increasingly complex. The customers will be confused about a lot of these schemes and wonâ€™t be sure how much their effective interest rate is and how much they are getting etc. This type of thing happens with most financial products, and this might not be any exception to it.

5. Interest rate fluctuation: Just as fixed deposit rates fluctuate, short term savings rate will also fluctuate with changing times, and consumers will have to get used to this new reality.

6. Different interest rates for different balances: It is possible that banks set two interest rates, one for lower balances and another for higher ones. This is already done for fixed deposits, and might also be done for savings account in the future.

What other things can you think of? I think this should be a good move for some if not all customers, but will hit the bank margins a little.

What I learned from the mattress salesman

I have been spending more than my share of time with salesmen these days, and I’ve realized that I have a lot to learn from them. I learned something today as well, or rather saw a technique in action – which I had read about earlier. I accompanied a friend who wanted to buy a mattress, and he had a certain price range in mind.

We went to a nearby store, and the salesman told us something about how the mattresses were color coded and left us alone for about ten minutes or so. I don’t remember the color coding exactly, but I think the firm ones had a red band on them, soft ones had a green band on them, and then the in-between ones had a yellow band on them.

After a few minutes, he approached us and told us about this fancy machine they had which was attached to a mattress that made recommendations for you based on your body type.

He asked my friend to lie down on the mattress for about a couple of minutes or so, and the mattress was attached to a screen which showed his posture, and how different points in his body were exerting pressure on it. The salesman told us how the machine was connected to databases of leading universities doing sleep research, and had over 4 million records in its database.

After a few moments, the system made a recommendation and the mattress that it recommended was about ten times the price of what my friend was looking at!

The salesman asked him to lie down on the mattress and see how it feels. Sure enough, it felt great, and then the salesman started explaining how each body is different, and needs different types of mattresses. He asked my friend to lie on another expensive mattress and told him he wouldn’t like it, and that turned out to be true too.

Finally, my friend told him that this is all well and good, but he wants something that is way cheaper than what was being shown, and told him the top price he was looking at.

The sales-guy said that you really don’t have to buy this one – we just use this to run diagnostics, and based on its recommendation – I will get you something that is closer to your price range. He then showed us a few that were closer to the top price – some less, and some more than it.

After trying out a few – my friend picked out one that was much higher than the top price he was looking at, even when there were cheaper options that weren’t so bad.

As I thought about his experience on the ride back home, I realized that I had read about this technique somewhere, most probably in this book called Influence, but I am not really sure about it. What happened was that the sales-man showed us a top of the line thing, which then set an anchor price in our head, which was quite a big amount.Â He didn’t actually talk about the price even once, but I am sure this amount was playing in our heads the entire time.

So now instead of the original budgeted price, this new figure which is much larger becomes a point of reference. So, when you look at other options, you start thinking about them with respect to the most expensive thing you saw, not the amount you originally had in your head. So, even something that is way higher than your top price doesn’t look all that bad, because it is so much less than the new anchor price in your head.

I thought this was quite an interesting experience, and a very effective technique as well. I’d like to hear if anyone else has any similar experience or other interesting stories about sales techniques.

Image by Heather