Step-up strategy

Most people fund retirement out of a fixed monthly amount. The trouble is that the fixed amount is set at the start, when income is lowest.

So the early years are the hardest. An emergency, a loan, a school fee, and the contribution gets cut or stopped. The goal slips.

A step-up strategy answers that. The saver starts with a smaller amount and raises it by a set percentage every year.

Income usually rises every year too. A bonus, a hike, an increment. The step-up lets the contribution rise with it.

The workbook's own guidance is modest. If income rises by 10%, step up the investment by at least 5% to 7%.

It can be done through EPF, through NPS, or through mutual funds.

What the strategy is. In a stepping strategy, contributions are stepped up periodically, either with regular payments or with a lump sum. In a periodic step up strategy, the individual starts with a fixed investment but steps it up by a certain percentage every year.

The three routes the workbook names.

How much to step up by. The step is set against current income, expected yearly increments and the financial goals. The workbook's rule of thumb: if income increases by 10%, the investor can step up the investment amount by at least 5% to 7%. Every annual bonus, hike or increment is an occasion to step up the SIP.

Why it works at all. Not everyone can generate a high saving at the outset. Starting with a lower amount means the requirement increases with time, and the saver loses some compounding benefit on the early years. The step-up strategy increases the investment in proportion to income as income rises, which is what lets the wealth compound at all rather than the plan being abandoned.

The honest trade-off. The same passage that recommends stepping up also warns about starting low. Both statements are in the workbook, and they are not in conflict: a lower start costs compounding, and a plan that is actually sustained beats a higher fixed plan that is abandoned in year three.

Its mirror image in the same chapter. Section 6.2 also covers the impact of pre-retirement withdrawals, which works the other way. The workbook's figure there: a withdrawal of Rs 75,000 from an EPF balance 30 years before retirement potentially costs Rs 8.66 lakh at 8.5% per annum.

The workbook's own example. Mr A has to accumulate a retirement corpus of Rs 2.0 crore in 20 years. Assuming a return of 12% per annum, he needs a monthly fixed saving of Rs 20,217 to reach the goal, using the PMT function in Excel.

The workbook then says that if he steps up his monthly contributions by 7% annually, he can start with lower contributions and increase them each year.

The workbook does not print the starting figure for the stepped-up plan. Working it out from the workbook's own four inputs - Rs 2 crore, 20 years, 12% a year, 7% annual step-up - gives:

Read both rows of that table before recommending it.

What the client gains. The first year costs about Rs 7,457 a month less - Rs 12,760 against Rs 20,217. For a 30-year-old whose salary will not support Rs 20,217 today, that is the difference between starting the plan and not starting it.

What the client pays for it. He ends up putting in roughly Rs 14 lakh more in total, because the rupees that were missing in the early years were the ones with the longest time to compound. That is the workbook's warning about starting with a lower amount, in figures.

Chapter 6 (Miscellaneous aspects of Retirement Planning), section 6.2, Benefits of stepping up Investment in the accumulation years, sets out the strategy, the three routes, the Rs 5,000 plus 10% step-up SIP illustration, the 5% to 7% guidance on a 10% income rise, and the Mr A example with its Rs 20,217 monthly figure. The same section continues into pre-retirement withdrawals and the transfer of a corpus between employers. Expect a PMT computation of the fixed monthly contribution, and a conceptual question on why a step-up plan suits a saver early in their career.

• Rs 20,217 is the FIXED monthly saving, not the step-up starting amount. The workbook gives only the fixed figure, and a question quoting it is asking about the level plan.
• Step up by 5% to 7% when income rises 10%. The workbook does not say match the income rise rupee for rupee.
• The 7% in the Mr A example and the 10% in the SIP illustration are different numbers. One is his annual step-up rate; the other is the step in the mutual fund illustration.
• Stepping up does not create a bigger corpus for the same money. It reaches the same corpus with a gentler start and a larger total outlay.
• VPF is the route the workbook names for savers aged 50 and above, not for everyone who wants to step up.
• NPS has no upper limit on investment, which is why it is named as a step-up route - but the tax deduction on it is capped, which is a separate question.
• Step-up is not the same as a lump sum top-up. The workbook allows both, but the periodic step-up strategy specifically means raising the recurring amount by a percentage each year.