Foundation — The five life stages, budgeting, and setting the retirement goal

The retirement planning process — foundations

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1. What retirement planning is

The logic runs in a chain, and it is worth seeing the direction it flows:

"THE LIFE STYLE ENVISAGED will define THE EXPENSES AND INCOME REQUIRED in retirement, which in turn will SET THE GOAL FOR RETIREMENT SAVINGS."

⚠️ Notice that the money is the last item, not the first. You cannot compute a corpus until you know what life you intend to live. This is why every serious retirement calculation begins with an expense list, never with a savings figure.

"Planning for retirement is about LINKING THE CURRENT FINANCIAL SITUATION WITH THE EXPECTATIONS FOR THE FUTURE and having a strategy in place to secure the financial future."

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2. Evaluating the client's current situation

"Understanding the current financial situation of the individual is VITAL in framing a viable retirement plan." What must be collected:

⚠️ Why each matters — "all this information is evaluated to understand the elements that are central to planning for retirement savings including:

• THE ABILITY TO SAVE
• THE INVESTMENT HORIZON available to accumulate the savings.
• THE RISK TOLERANCE LEVELS that will determine the TYPES OF INVESTMENTS that can be used.
• THE ACCUMULATED WEALTH available that can be APPORTIONED TO THE RETIREMENT GOAL".

That word fuse is doing real work. A plan that only reflects hopes is a wish; a plan that only reflects constraints is a surrender. The adviser's job is the joining of the two.

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3. The life cycle and its impact on saving

"Financial needs and financial compulsions vary NOT ONLY ACROSS INDIVIDUALS BUT ALSO ACROSS TIME PERIODS FOR EACH INDIVIDUAL... The income and expenses, debt levels, ability to take risks and goal priorities are ALL DYNAMIC."

The workbook's two illustrations of that dynamism:

• "DEBT REPAYMENT may take a large portion of the income in the EARLY AND MID-EARNING YEARS, but ARE NOT SO SIGNIFICANT LATER IN LIFE".
• ⚠️ "The availability of an EMERGENCY FUND to tide over unexpected short-falls in income is CRITICAL FOR THE YOUNG EARNER WITH A DEPENDENT FAMILY, BUT NOT SO IMPORTANT FOR A RETIRED INVESTOR".

"One way to incorporate the demographic and economic factors specific to each stage of life into the planning process is TO CONSIDER THE LIFE CYCLE OF THE INDIVIDUAL... Despite the uniqueness of each individual's situation THERE ARE SOME COMMONALITIES."

3.1 Young Earner

"At this stage INCOME IS NOT VERY HIGH and just about adequate to meet expenses."

• ⚠️ "Creating an EMERGENCY OR RESERVE FUND to manage any possible loss or reduction in income SHOULD HAVE FIRST CLAIM ON SAVINGS".
• ⚠️ "Any MANDATORY SAVINGS, such as provident fund deductions from income, SHOULD BE ASSIGNED TO LONG TERM GOALS SUCH AS RETIREMENT".
• "While long-term goals like retirement exist, at this stage PRIORITY IS GIVEN TO SHORT AND MEDIUM-TERM CONSUMPTION GOALS like buying a motor vehicle and lifestyle goods".
• "There is A RISK OF FALLING INTO DEBT to meet consumption demands or even essential expenses in case of loss of income. Repayment of debt, such as EDUCATIONAL LOANS AND CONSUMPTION LOANS, becomes a strain on income for a long time".
• ⚠️ "FLEXIBILITY in making investments to align to income conditions is important... BEING TIED TO A LONG-TERM COMMITMENT, SUCH AS A HOME LOAN EMI, WHEN INCOME STABILITY IS NOT THERE CAN BE RISKY".

Portfolio: "Hold an emergency fund in SAFE AND LIQUID SHORT-TERM INVESTMENTS. Savings assigned to long term goals should be invested in GROWTH ASSETS LIKE EQUITY." ⚠️ "The allocation to growth assets SHOULD MOVE UP AS THERE IS GREATER STABILITY TO INCOME."

3.2 Young Family

"Household income is likely to be STABLE, THOUGH STILL NOT VERY HIGH relative to the expenses that have to be met. Expenses are mainly DISCRETIONARY expenses for a lifestyle they aspire to live. Debt may still be a concern... especially if the family has bought a home."

• ⚠️ "At this stage the young family will have PROTECTION AS A PRIORITY. This will be primarily in the form of INSURANCE AND EMERGENCY FUND".
• "The amount of savings available after meeting all these essential claims will be LIMITED, but whatever is available can be invested in asset classes capable of earning HIGHER RETURNS ALBEIT WITH HIGHER RISK".
• ⚠️ "PLAN AHEAD FOR CHANGES, such as MOVING FROM A DOUBLE INCOME TO SINGLE INCOME FAMILY or moving to being SELF-EMPLOYED, that may DISRUPT INCOME FLOWS".

Portfolio: ⚠️ "An allocation of 60 PERCENT TO 70 PERCENT IN GROWTH ASSETS such as equity to meet long term goals is advisable at this stage."

3.3 Middle Earning Years

⚠️ "This is typically THE PEAK EARNING YEARS and income levels at this stage are HIGH AND STABLE. Expenses are likely to have STABILIZED too leading to HIGHER SAVINGS. Debt levels are likely to be STEADY AND EASILY SERVICED."

• "Some goals, such as THE EDUCATION OF CHILDREN, MAY BE CLOSE and require MOVING FUNDS TO LESS VOLATILE INVESTMENTS".
• ⚠️ "Other goals, like retirement, MAY STILL BE 15-20 YEARS AWAY and STILL ELIGIBLE FOR GROWTH-ORIENTED INVESTMENTS".
• ⚠️ "THIS STAGE IS A GOOD TIME TO CATCH UP ON ALL THE SHORTFALL IN RETIREMENT SAVINGS by apportioning larger portions of available savings to it".
• "There is GREATER CLARITY ON LIFE STYLE PREFERENCES, INTERESTS AND HEALTH ISSUES, all of which are important for firming up the retirement plans".

Portfolio: ⚠️ "50 PERCENT TO 60 PERCENT IN GROWTH ASSETS with a plan to SYSTEMATICALLY REDUCE EXPOSURE AS GOALS COME CLOSER."

3.4 Pre-retirement

⚠️ "PRESERVATION OF ASSETS IS CRITICAL at this stage as earning years are coming to an end soon."

• "While CONTRIBUTION TO RETIREMENT WILL CONTINUE, this is the stage to MOVE ACCUMULATED INVESTMENTS TO LESS RISKY INVESTMENTS".
• ⚠️ "PAYING OFF ANY REMAINING DEBT and REFRAINING FROM TAKING ON ANY LONG-TERM OBLIGATIONS is important at this point".
• ⚠️ "This is the stage when THE DISTRIBUTION OR INCOME STRATEGY for retirement SHOULD BE FINALIZED and there is likely to be MORE CLARITY ON THE LENGTH OF RETIREMENT PERIOD".

Portfolio: ⚠️ "Lower risk income-oriented assets such as INCOME FUNDS AND DEPOSITS, WITH SOME EXPOSURE TO GROWTH. Around 60 TO 70 PERCENT of the portfolio should be allocated in LOWER RISK PRODUCTS at this stage."

Read that carefully — the 60–70 percent here is in lower risk products, the mirror image of the Young Family stage where 60–70 percent was in growth assets. Mixing up which side of the fence the number sits on is a classic exam slip.

3.5 Retirement

"At this stage THE LEVEL OF EXPENSES IN RETIREMENT IS KNOWN and the decision on how to fund them has to be decided."

Funding sources: "any EMPLOYER-LINKED PENSION, the INCOME GENERATED FROM THE CORPUS accumulated, PART-TIME EMPLOYMENT or A COMBINATION."

"While deciding on investing for income, THE TAX IMPLICATIONS, NEED FOR ASSURANCE AND RISK LEVELS have to be considered." ⚠️ "CARE SHOULD ALSO BE TAKEN TO INVEST SOME PORTION OF THE CORPUS IN GROWTH ASSETS TO BEAT INFLATION."

Portfolio: ⚠️ "PREDOMINANTLY INCOME-ORIENTED, with NOT MORE THAN 25 PERCENT TO 30 PERCENT IN GROWTH ASSETS."

3.6 The five stages side by side

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4. Budgeting to realise savings

"The age and stage of life gives an understanding of the ability to save and the risk profile. BUDGETING IS AN EFFECTIVE WAY TO REALIZE THE POTENTIAL TO SAVE."

The four steps, and they run in this order:

1. "LIST THE REGULAR INCOME expected in the month. This is the income available to meet current and future needs".
2. ⚠️ "List the MANDATORY EXPENSES that have to be met like TAXES, LOAN REPAYMENTS. These have to be FIRST MET out of the available income. WHAT REMAINS IS THE DISPOSABLE INCOME".
3. "The ESSENTIAL LIVING EXPENSES have to be met out of disposable income next. These include HOUSING, FOOD, TRANSPORTATION, HEALTH and other necessary expenses. While this category CANNOT BE ELIMINATED, IT IS POSSIBLE TO REDUCE THE COST INCURRED ON THEM".
4. "DISCRETIONARY EXPENSES are the LAST category and includes expenses on ENTERTAINMENT AND RECREATION".

"There should be A TARGET to generate a PRE-DEFINED AMOUNT of savings each period." ⚠️ "AD HOC OR IRREGULAR SAVINGS DOES NOT SERVE THE PURPOSE of creating the corpus required to meet the goals."

4.1 Expanding income versus controlling expenses

How to control them: "It is possible to RATIONALIZE ESSENTIAL LIVING EXPENSES by choosing A LESS EXPENSIVE PLACE TO LIVE or A CHEAPER MODE OF TRANSPORT... THE DISCRETIONARY EXPENSES ARE IN THE CATEGORY THAT CAN BE CUT BACK OR EVEN ELIMINATED to reach the savings required."

⚠️ The caution that keeps budgets alive: "To be workable, A BUDGET NEEDS TO BE REALISTIC. VERY NARROW ALLOCATIONS TO EXPENSES OR ELIMINATING ALL EXPENSES RELATED TO AN INDIVIDUAL'S INTERESTS OR HOBBIES CAN BE STRESSFUL AND LIKELY TO FAIL."

4.2 The three household ratios

"These ratios give an indication of whether the household is managing income and expenses as they should to reach their goals. IF NOT, CHANGES NEED TO BE MADE IN THE BUDGET TO GET SAVINGS BACK ON TRACK."

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5. What makes the retirement goal unique

And the timing paradox at its heart: ⚠️ "Though the income required to meet expenses in retirement CAN BE DEFINED WITH CERTAINTY ONLY CLOSE TO THE TIME OF TRANSITION TO RETIREMENT, THE ACCUMULATION OF THE CORPUS HAS TO BE DONE FROM THE BEGINNING OF AN INDIVIDUAL'S WORKING YEARS."

You must start saving decades before you can know how much you need. That is not a flaw in the method; it is the nature of the goal, and it is why the workbook insists on two things: "ADEQUATE RIGOUR in determining the variables" and "PERIODIC MONITORING to incorporate changes, if any, into the goal."

The two footnoted definitions to fix now:

• ⚠️ ACCUMULATION STAGE — "the stage in which THE SAVING AND INVESTMENT FOR THE RETIREMENT CORPUS IS MADE".
• ⚠️ DISTRIBUTION STAGE — "when THE CORPUS CREATED IN THE ACCUMULATION STAGE IS EMPLOYED TO GENERATE THE INCOME required to meet expenses in retirement".

The process in one sentence: "Determining the retirement goal is about DEFINING THE INCOME THAT WILL BE REQUIRED to meet living expenses in the period when there is no income being earned from employment. Once this is done, the planning process deals with HOW TO ACCUMULATE THE CORPUS required, and USE THIS CORPUS TO GENERATE THE INCOME."

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6. Expenses in retirement

⚠️ "THE FIRST STEP in retirement planning process is TO DETERMINE THE EXPENSES that have to be met in retirement. The expense in retirement is UNLIKELY TO BE THE SAME as prior to retirement."

Which way each moves:

⚠️ And it does not stop moving: "EVEN IN THE RETIREMENT PERIOD THE EXPENSE PROFILE IS LIKELY TO UNDERGO CHANGE OVER TIME."

The full list of retirement expense heads: HOUSING (including utilities, maintenance cost, taxes) · LIVING EXPENSES (food and personal upkeep) · MEDICAL CARE · TRANSPORTATION · RECREATIONAL EXPENSES · INSURANCE (life, health, disability) · TAXES

The Retirement Expenses List (Table 3.1) breaks these into line items:

6.1 The housing decision

⚠️ "IDEALLY, MORTGAGES AND OTHER LARGE DEBT OBLIGATIONS SHOULD BE PAID OFF BEFORE RETIREMENT."

On renting: "Renting is an option instead of buying a home and MAY PROVIDE GREATER FLEXIBILITY IN DECIDING ON WHERE TO LIVE IN RETIREMENT. HOWEVER, IT MAY BRING IN AN ELEMENT OF UNCERTAINTY ON HOUSING COSTS AND AVAILABILITY, WHICH MAY BE DIFFICULT TO DEAL WITH LATER ON IN RETIREMENT."

Both sides are stated, and neither is declared the winner — flexibility early, uncertainty late.

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7. Determining income required in retirement — the two methods

7.1 Income Replacement Method

"It is THE PERCENTAGE OF THE INCOME JUST BEFORE RETIREMENT that will be required to MAINTAIN THE DESIRED STANDARD OF LIVING in retirement."

Why the composition shifts even when the categories stay the same:

• "MEDICAL AND HEALTH CARE expenses is likely to be A BIG COMPONENT IN LATER YEARS of retirement".
• "TRANSPORTATION AND TAX OUTGO is likely to be LOWER in retirement years".
• "RECREATIONAL expenses may be HIGHER".
• "Expenses towards CHILDREN'S EDUCATION is typically NOT THERE in retirement".
• ⚠️ "THE PORTION OF INCOME THAT WAS GOING TOWARDS NECESSARY SAVINGS in the pre-retirement stage WILL NOW NO LONGER BE REQUIRED".

⚠️ When the ratio should be LOWER: "This number may be LOWER IF A LARGE PART OF THE PRE-RETIREMENT INCOME WAS GOING INTO SAVINGS. This is very likely the case with many individuals who HIT A PHASE OF HIGH INCOME IN THEIR EARLY 50s, and with much of the large-ticket expenses already taken care of, a large portion of the income may go into savings. In such a case, the income replacement ratio is likely to be MUCH LOWER since the SAVING AND PROBABLY TAX COMPONENT would account for a large part of the pre-retirement income."

When to use it: ⚠️ "IN THE INITIAL YEARS OF PLANNING, when there is LESS CLARITY on the future income, it is more convenient to go with THUMB RULES. But as the income and expense situation becomes clearer, ESPECIALLY IN THE LAST 5-10 YEARS BEFORE RETIREMENT, IT IS BEST TO CONSIDER THE PARTICULAR SITUATION OF EACH INDIVIDUAL."

Its honest limitation: "Simple to follow and useful to set a target for savings when retirement is some time away. BUT LIKE ALL RULES OF THUMB IT DOES NOT TAKE INDIVIDUAL CIRCUMSTANCES INTO CONSIDERATION. For example, ASSUMING THAT EXPENSES IN RETIREMENT WILL AUTOMATICALLY GO DOWN MAY BE ERRONEOUS."

The five steps:

1. Calculate the current income
2. Estimate the rate at which income is expected to grow over the years to retirement.
3. Calculate the years to retirement.
4. ⚠️ Income at retirement = CURRENT VALUE × (1 + RATE OF GROWTH) ^ YEARS TO RETIREMENT.
5. Apply the income replacement ratio to arrive at the income required in retirement.

The worked example — Pradeep:

7.2 Expense Protection Method

"The focus is on IDENTIFYING AND ESTIMATING THE EXPENSES LIKELY TO BE INCURRED IN THE RETIREMENT YEARS and providing for it. Typically, the expenses required in retirement is taken as A PERCENTAGE OF THE EXPENSES JUST BEFORE RETIREMENT — the assumption being that POST-RETIREMENT EXPENSES WILL NOT INCLUDE CERTAIN EXPENSES SUCH AS TRANSPORT, HOME LOAN EMI. On the other hand, the expenses on other heads SUCH AS HEALTH IS LIKELY TO BE HIGHER."

⚠️ Its drawback: "Expense Protection is A SLIGHTLY CUMBERSOME METHOD due to the DETAILED LISTING REQUIRED of expenses incurred post-retirement. ESTIMATING THIS WRONGLY MAY MAKE THE DETERMINATION OF RETIREMENT CORPUS INACCURATE."

The process: "Prepare a list of PRE AND POST-RETIREMENT EXPENSES, arrive at the TOTAL EXPENSE LIST. The expense so calculated HAS TO BE ADJUSTED FOR INFLATION over the period of time left to retirement."

⚠️ The specific danger: "IF EXPENSES ARE OVERLOOKED OR UNDERESTIMATED THERE IS A RISK OF OVERSPENDING IN RETIREMENT, since the income required would be CALCULATED LOWER THAN WHAT IS ACTUALLY REQUIRED."

The worked example — Pradeep again:

⚠️ Note what happened here — only the HOUSEHOLD portion (60%) of the current Rs 50,000 was carried forward, because the other 40% will not be incurred in retirement. Then Rs 10,000 of NEW discretionary spending was ADDED. Both directions, in one calculation. Blindly inflating the full Rs 50,000 would have given Rs 2,14,594, an overstatement of about 25 percent.

7.3 The two methods contrasted