Real Returns. The risk of living too long

I attended an 80th birthday celebration recently and met many sprightly 80 to 90-year olds. As they exchanged notes about foreign trips to visit grandchildren, hobbies and their many little ailments, what struck me was that they hardly discussed their finances. There was good reason for this.

As all of them had retired from the Indian government more than 20 years ago, and their living expenses were taken care of by employer-funded, inflation-adjusted monthly pensions.

Our generation will not be so lucky. Thanks to our neighbourhood agent, most of us have bought life insurance covers to take care of our dependents in case of our untimely death.

But rising longevity, for investors, is a risk too. It is a very live risk for this generation, because life expectancy in India is rising rapidly. The average life expectancy has climbed from 52 years in the 1980s to 66 years by 2012 (Census data) — that’s roughly five years added to the average life-span every decade.

Women and more affluent people should expect to live much longer. Therefore, if you are in your thirties today, you can reasonably expect to live on to your mid-eighties.

That means planning for 25 years of post-retirement life. This calls for four changes to your financial plans.

Rising longevity suggests that you should worry as much about securing your own health insurance needs post-retirement, as about a life cover to protect your dependants.

So if you’re paying a hefty premium towards an endowment or whole life plan, in addition to a pure term cover, think seriously about surrendering or stopping it, and using that premium to buy a good health insurance cover.

Taking a liberal health cover in your thirties or forties makes eminent sense, because general insurers turn wary of offering these covers to anyone over the age of 60.

Regulations require insurers to mandatorily renew your health cover (once taken) on a lifelong basis. So take both a health policy and a critical illness cover (ensuring say ₹15 lakh or ₹20 lakh) in the first half of your career, so that it can last you a lifetime. Look for insurers who offer a lifelong renewal option on critical illness, even if the premiums are slightly stiffer.

When they retire, most people without a pension don’t have a concrete plan for regular income in their post-retirement years. They plan to invest in fixed deposits or bonds.

But assuming you live on for 25 years post-retirement, this strategy will subject you to substantial re-investment risk.

Re-investment risk is the risk that your returns (interest rates) will get reset lower every time your deposit matures, and you need to re-invest that money.

Just think of a long-living retiree 20 years ago, who decided to rely on bank fixed deposits for his pension needs. In 1995, he would have received 11 per cent annual interest from his five-year bank FDs.

As those matured in 2000, the rates were down to 10 per cent. In 2005, he would have had a nasty shock in store, as bank FD rates plunged to 5.75 per cent. In 2010 and 2015, he would have been able to lock in at 7.50 and 8.75 per cent respectively.

These swings in interest rates would have made for wild fluctuations in his monthly income. Reinvestment risk can really dent your income if interest rates trend down over the long term.

Given that the long-term trajectory of rates in developing economies like India is expected to be down, today’s retirees have even more reason to worry about reinvestment risk. To avoid such unpredictable income, the best bet for a retiree would be to lock into fixed income options for as long a tenure as possible.

Unfortunately, India does not have too many fixed income options that go beyond five years. Tax-free bonds (10 and 15 years) are one option. Immediate annuity plans are another.

HDFC Life’s Immediate Annuity plan, for instance, offers an annual income of ₹9,380 for as long as you live, for an upfront one-time premium of ₹1 lakh. For a retiree who lives to 75, that translates into a 5 per cent pre-tax return or a post-tax return of a meagre 3.9 per cent. But for a retiree who lives to 85, the returns would be 8 per cent (post-tax 6.2 per cent).

Immediate annuity plans are the only investment where the seller and not you, bears the risk of longevity.

But annuity plans, though they offer predictability, don’t keep up with inflation. And yet inflation can be as debilitating in your post-retirement years as it is during your working life.

Most of us, when working out our required retirement kitty, factor in the impact of inflation during the accumulation years.

Imagine if you spend ₹30,000 a month towards living expenses today and you are 40 years old. Inflation at 6 per cent would expand that requirement to over ₹96,000 by the time you retire (at 60).

But your problems don’t end there. You will find your living expenses of ₹96,000 at 60 shoot up to ₹3 lakh by the time you are 80!

This requires you to make sure that a part of your investments, post-retirement, continue to deliver inflation-beating returns.

So even if you have FDs or an annuity plan, you could park 25 percent or so of your corpus in balanced funds and use systematic withdrawals for ‘income’. This income however would vary depending on market conditions. Owning rental property with good yield can shield you against inflation too.

Finally, if you have money left over, you may also like to explore retirement homes or assisted living options to see you through later years of poor health.

Given how difficult it is to save even for one’s own retirement, it would be best not burden one’s children with our post-retirement needs.