Retirement Planning Global- Chapter-1 & 2

Preface Retirement planning in a financial context refers to the process of making financial provision for retirement. This normally results in the purposeful setting aside of money or other assets, with the intention of deriving an income from those assets at retirement. The goal of retirement planning is to achieve financial independence, so that the person should not be compelled by circumstances to work after retirement. Retirement planning is the process of establishing an income goal and gathering information about its potential sources at retirement. In other words, retirement planning is a process, which starts with estimating how much income a person will require after retirement to maintain a comfortable standard of living. Can you imagine your future with the financial support from your family if you didn’t see the value in planning for retirement? It would then become your children’s responsibility to take care of you. In your retirement, you shouldn’t be dependent on anyone, let alone your own family. Having a firm plan in place will make sure you don’t become a financial burden on those you love the most. You want to be in a position to help out a family member’s financial situation, not make things worse. Retirement planning is a part of financial planning addressing one’s purpose and aims to: ➣ Assess a clients’ readiness-to-retire given a desired retirement age and lifestyle, i.e., do they have sufficient money to afford such a phase? ➣ To identify clients’ decisions or actions to improve readiness-to-retire Retirement planning encompasses the plans and actions that individuals engage in to prepare for a smooth transition, from a life based mainly around working, to a life based mainly around not working. Retirement planning is especially important for business owners because their retirement is their own responsibility. With no company PF/Gratuity/Pension Plan as support, their standard of living in retirement is up to them. One of the first steps of retirement planning is to assess your current financial situation and figure out how it relates to your goals for retirement. CFP Level 2: Module 1 – Retirement Planning Page 1

Therefore, it is an “honest attempt” to figure out the amount of money you would need to invest every month in order to lead a comfortable retired life. The reason we say it an honest attempt is because it requires you to predict the future, which is almost impossible. For example, what sort of returns will your investments get over the next 20 or 30 or 40 years? How will the rate of inflation change over this time period? It is difficult to answer these questions with certainty. However, it is possible to take a careful look at the past, and make some educated guesses about the future. Traditionally, retirement signifies a release from the toil of work. Retirement means freedom and, with luck, an active, carefree leisure—relaxation and a chance to pursue long-postponed dreams and ambitions. By age 55-56, the individual should have discharged all his worldly duties i.e. Children’s education, their marriage and should be saving enough for his comfortable retired life. Once he is retired having a good corpus, the couple can spend more time on pursuing hobbies, give more time to yoga and meditation and on self-improvement. People see retirement planning as something that could be postponed till tomorrow. The fact is that the earlier you start, the more you are able to accumulate. Pension by employers used to be a regular source of income after retirement till a person is alive, but now even central and state governments have shifted to Defined contribution system in place of Defined Benefit plan. As there are no defined pension benefits, it becomes all the more important to plan for retirement. This course will explore retirement planning areas including:  Understanding clients’ retirement goals  Determining funding amounts needed to provide required retirement cash flow  Options for accumulating desired funds  Assessing available resources  Distribution options and concerns, including ensuring funds last throughout the client’s lifetime This course will explore retirement planning to prepare you to develop strategies and use techniques for wealth accumulation and withdrawal during retirement years; taking into consideration asset locations and the client’s personal financial goals, risk tolerance, risk capacity, and structure and impact of public and private retirement plans on the client’s financial plan. CFP Level 2: Module 1 – Retirement Planning Page 2

Chapter-1 Retirement Principles Learning Objectives Upon completion of this section, students should be able to:  Explain the value of planning for retirement  Analyze strategies for funding retirement Topics  Value of early and consistent planning for retirement  Investing for retirement • Accumulation strategies Introduction When a person works in any organisation, retirement age is mandatory so he is very well aware about number of his working years and age of retirement. Sometimes poor health can make continuing to work a practical impossibility. In that case, he has to plan more efficiently as number of working years will be less as compared to earlier and more number of years are shifted to distribution stage ( when income stops). When there is no mandatory retirement age, the decision to retire can be more complex. Social and cultural norms can influence the decision, as can relational issues, personal life choices and goals. Additionally, the need to accumulate sufficient money to fund retirement can greatly affect the decision. This chapter will begin by looking at some non-financial retirement planning aspects. Then, it will explore the financial implications of building an investment portfolio to fund client goals. In the process, we will have to evaluate consumer attitudes toward retirement planning and consider education to provide guidance. CFP Level 2: Module 1 – Retirement Planning Page 3

Meaning of Retirement What does retirement mean? You can expect many answers to this question. Earlier people used to wait for retirement so that they can sit around in a rocking chair and getting older every day. These dreams are no longer valid for most people. Retirement can mean starting a new business, getting additional education, travelling the world or to see children and grandchildren, shifting from one job to another, consulting, expanding hobbies, donating time for charitable causes, and much more. At some point it may even include relaxing in a rocking chair. When you have to start conversation with your clients about what is their understanding about retirement, it is not just an interesting conversation starter. A person’s view of their retirement will provide the foundation for developing their retirement plan. A plan for someone who intends to spend most of retirement sitting at home and one who wants to get an advanced university degree or start a new business will involve different approaches. Therefore the firstand most important retirement planning step is to gain a clear understanding of what retirement looks like to the client. Have you heard “I have stopped working but I have not stopped earning”? We all assume that once a person reaches retirement age, he or she wants to stop working. If this is the case, the primary planning goal becomes providing enough money so the individual has sufficient capital or available cash flow to stop working. However, while leaving a current full-time job may be desirable; ceasing to work or remain active is rarely the goal. Let’s look at a variety of activities clients may take up in retirement.  Additional education: A person may wish to join some course of his interest and go back to university to continue education and perhaps get an advanced degree. He has to provide extra money for the education. The newly retired person may have the time and the desire to study. However, in addition to the personal satisfaction gained, it is also possible that an advanced degree may help the retiree qualify for a new job, or start a new business. In this case, even though the education is a financial drain initially, the new degree or skills might help generate additional cash flow over time, which could eventually offset the initial expense.  Giving back: Some retirees plan to give back to society as they spent lifetime in earning a living. It is the time to give back to society. Top executives may take the opportunity to coach entrepreneurs or newly minted managers on how to succeed in business. Lawyers might provide legal services for non-profit organizations at little or no charge. Teachers may help educate children who cannot afford a coaching. Healthcare professionals may join an organization to provide medical care for those who would otherwise have little or none. CFP Level 2: Module 1 – Retirement Planning Page 4

All these activities will involve spending. A person has to plan separately for these activities during his working life itself. Sometimes, individuals keep a percentage of their corpus for contributing to society.  Starting a business: Starting a business is a dream of many retirees. Since they could not start the business earlier as they had to meet various family responsibilities, they want to start their dream business now. They may be avid gardeners and want to share their knowledge and the fruit of their labours with others. People sometimes want to expand a hobby into a business or grow a small business into a larger one. Doing this can be extremely rewarding, and potentially lucrative. However, business start-ups do not come with cash flow guarantees, and often result in much more cash flowing out than in. If successful, a new business can provide a good retirement cash flow supplement. However, the individual should carefully consider the amount of money he or she is willing to invest in a new venture to put a cap on the resource- draining potential.  Travel and hobbies: Today’s retirees look forward to travelling during retirement. There are many places to see and cultures to experience. Also, parents want to spend time with children and with grandchildren. Retirement seems the perfect time to travel, and it is, as long as the client’s health and money are there to support this activity. In fact, there are a few activities that fit into this category. Retirement provides the free time to do new things, but the client must exercise care in the amount of money allocated to these types of recreational pursuits. This is especially true during the early years of retirement, because once money is gone; it is gone, with little opportunity for the client to earn more. Earning money becomes difficult after retirement so planning spending very carefully becomes very important.  Working at a new job: May people wish to retire from their present hectic job and start a new job which gives them more time for rest and recreation. A person might have worked for the same employer for many years, and likes his or her job, but wants a venue change. While not guaranteed, a cut in cash flow would likely accompany such a change. Loss of benefits (e.g., healthcare or pension) is another area that could be an issue. On the other hand, shifting to a part-time or consulting arrangement can be a good way to supplement retirement cash flow, and can also serve to keep the retiree active. This list is in no way exhaustive. There can be more options which can be considered by retirees to keep themselves busy and healthy. One can become Yoga instructor; it will help in himself maintaining good health and also contribute to society by making people aware about benefits of yoga. Each of the activity also has the potential to have either a positive or negative impact on retirement cash flow. It is CFP Level 2: Module 1 – Retirement Planning Page 5

important to remember that there are no right or wrong options (except, of course, those that are illegal or demonstrably unsound financially). Understanding Client Goals For financial advisor, understanding the goals of clients is very important before giving them any recommendation. There are several implications, including those that specifically are financial and may impact funding for the individual’s desired retirement choices. You should have good listening skills to have deeper understanding of client’s goals. How will you do this? Roy Diliberto, in his book Financial Advice: The Next Step suggests the following to guide the process (Diliberto, 2006, p. 69):  Begin the dialogue by reviewing clients’ answers to preliminary questionnaires.  Ask about the future – not retirement.  Help them to discover what is important to them.  Uncover current and future transitions.  Ask about your clients’ attitudes about charitable giving.  Be a biographer – ask about your clients’ histories.  Discover your clients’ values and attitudes about money. Diliberto encourages advisors to get to know their clients. Don’t just know about them, know them. Understand the client’s values, his or her dreams. Learn about their personal and family history to uncover what is important to them, and the concerns they have. Focus on the present but also learn what they hope to accomplish in the future. Some part of the process might include guiding them to look beyond themselves to helping others. All of these things will help the advisor understand client goals, and help him or her to develop an appropriate retirement plan. Importance and Relevance of Retirement Planning: A comprehensive financial planning of an individual should aim at more than one objective. Though, ultimately the aim of every plan is to have a more comfortable life, various stages of life require different kinds of planning. One of the important stages of life, which require careful planning, is retired life. As we have seen in the introduction, people no longer can look forward to retirement as a quiet phase of life to be spent with the family. Today, people anticipate vibrant retirement in which, they would like to enjoy life to the hilt without any financial dependency or penury. Now, this anticipation is easier said than done. In fact, achieving CFP Level 2: Module 1 – Retirement Planning Page 6

what is anticipated in retired life is the most difficult part of financial planning in today‘s environment. The difficulty is not merely because of the changes in the social fabric, whereby, informal joint family system, which was flourishing in our country till recent past, has started disappearing. It is the changes in the economic environment, the changes in the world of medical science and the increased longevity that add to the many woes of the persons in their retired life. It sounds rather ironical that certain advancements made in the world of science are actually seen as causes for increasing the worry of people. 1. Due to improvements in medical science, the longevity of the people and the capability of treating diseases, which were hitherto considered to be life threatening, have improved by leaps and bounds. 2. Greater urbanisation, improved living conditions and better facilities also resulted in reduced family sizes and mobility of labour. Hence, the joint family system with one earning member taking care of a bigger family consisting of members, who are not earning, is collapsing. With advancement of medical science, the cost of treatment of ailments has gone up manifold and it is almost becoming impossible to finance the medical expenditure unless it is planned through a system of healthcare financing. To cap it all, the working span of a person is also reducing, with longer educational span and reducing retirement age because of fall in productivity and efficiency of labour at old age, add to the problems or difficulty in planning for a longer and comfortable retired life. While these problems have become more acute with passing time, people who are in the prime of their youth do not realise the need for starting a retirement plan early in their working life. They are becoming more obsessed with the current needs and improvement in the quality of life of the present unless someone makes them aware of the need to plan for a retirement and set aside a portion of the current income towards creating wealth meant for retired life. It is here, that the role of financial planners like you become of crucial importance. This does not mean that you will straightaway put every client of yours into a state of panic by presenting a gloomy picture of the future and divert all his savings towards retirement benefit building. It only means that Retirement Planning has to be an integral part of the financial planning of every individual and the quantum and the proportion of the financial plan that will go towards retirement planning would depend upon many other factors that we would be discussing throughout this module. The basic characteristics of an individual‘s financial planning should include the following core issues: a) Maintenance of present family living standards and continuing the same in future through income support after retirement. CFP Level 2: Module 1 – Retirement Planning Page 7

b) Building up funds for emergencies like accidents, disability, critical illness or chronic sickness. c) Providing for expenses on large anticipated outlays such as purchase of residential accommodation, helping the children through financing expensive professional education and providing financial support for a start-in-life for them. Value of Early and Consistent Planning for Retirement Do the Hard Work Doing the hard work does not mean learning about clients goals and developing a plan (although it is time consuming) and also doing calculations to find out how much he needs to invest per month. The actual hard work is helping clients realize they have to adjust current lifestyles to achieve future goals. As Saly Glassman points out, you should expect to pay a price – either now or later – for the choices you make about handling your money (Glassman, 2010, p. 103). For many people, current lifestyle choices inhibit their ability to save for their future. As a result, a big part of retirement planning must focus on current cash flow management. Let us take an example to understand this. Assume a person will need to accumulate Rs.2 crore by age 65 to fund his or her retirement. If this individual begins setting aside money at age 30 and can earn an average annual return of seven percent, he or she would have to make annual periodic contributions in the amount of around Rs.1,35,215 to achieve the goal. This would mean the person has that amount less to spend for other pursuits. It also means that sometimes, the person may have to forego certain purchases that might otherwise be desirable. However, a person with that kind of retirement goal usually will be able to save a little more than Rs.11250 each month (@Rs.2812/week). Shift the timeframe forward 10 years, to starting at age 40 and the annual amount becomes almost Rs.295525. Waiting until age 50, the person must save almost Rs.743825 annually. By waiting to begin saving for retirement, the individual creates his or her own difficulties, to the point that eventually, the person has little or no hope of accumulating the required amount of money. The causal factor in all this is the individual’s lack of ability or desire to make the lifestyle changes early in adulthood required to support future dreams and goals. Getting the client to see this and act accordingly is the advisor’s hard work. Bigger Picture Here we are talking about how the client visualises his future during retirement. Many people are not able to articulate their future goals. Here the financial advisor needs to play a role. Money accumulation is very important but there is more to retirement planning than the money. Putting first things first requires understanding a client’s goals. Doing this is not necessarily as easy as you might think. Unfortunately, many individuals have difficulty articulating future goals. Further, a large group of CFP Level 2: Module 1 – Retirement Planning Page 8

individuals, when asked to envisage their retirement years, can barely bring to mind a vague picture of no longer working. Beyond that, they cannot foresee, let alone state, concrete plans or future goals. However, until the advisor can help a client do this, retirement planning will only be nominally effective. Without clearly stated goals, you have no way to know the ultimate destination. This means you also have no way to identify how much funding will be required, by when. Retirement Accumulation Investment Portfolio Let us assume that the client has at least 15 – 20 years’ time before beginning retirement. This time period is important, because when available time is much less, investment options get narrowed down considerably and the inherent investment risk factors also play its role. In fact, with only five years in which to accumulate funds, the individual will mostly be limited to bank fixed deposits, Post Office Time Deposits, Debt Funds of Mutual Funds and debt oriented Balanced Funds of Mutual Funds. Why have these limitations? Five years is too short a time to invest in any investment with normal volatility. There is a good possibility that the individual’s portfolio will experience a downturn at the time he or she needs the funds. Since retirement lasts quite a few years, there’s time to allow for greater investment diversity. However, during the initial retirement period, which normally coincides with higher spending levels, it will be important to focus on savings that have a much lower level of volatility (i.e., risk). Assuming that we have sufficient time to invest money to fund retirement, we can consider potential investment vehicles. The overall amount to invest is one of the first considerations. For individuals with relatively small amounts of investable income, focusing on collective/pooled investments (e.g., mutual funds, ETFs, UITs) will make the most sense. Individual stocks, bonds, real estate, and similar, may allow for more targeted investments, but using them also requires larger amounts of money to diversify properly. High net worth (HNW) clients may consider using more individual investment options, but they also may prefer collective/pooled investment options/Mutual Funds. While building a portfolio, taking too much risk is not sensible, taking too less risk is also not prudent. Greater return almost always requires accepting a higher level of risk. Individuals who are excessively risk-averse often put their funds in vehicles that barely have any earnings relative to inflation and the cost of living. While this may seem safe it will not help the individual address on-going purchasing power requirements. Average global inflation rates have averaged around three percent (with some countries like India experiencing rates that are 5-6%). In a three per cent inflation environment, the cost of almost any item will double in slightly less than 25 years (well within the average retirement period timeframe). CFP Level 2: Module 1 – Retirement Planning Page 9

Current interest rates on safe government or high-grade corporate investment notes around the world vary, but on average, are around two per cent or less (some countries even have negative interest rates). While individual putting money into one of these interest-bearing accounts is unlikely to lose principal, he or she is very likely to lose purchasing power over time, with applied interest not even keeping pace with inflation. This means an average person’s standard of living will gradually decrease. A more prudent approach is to invest money where the return is at least likely to equal or exceed the rate of inflation. This way, the individual can maintain purchasing power over time, and maintain a desired standard of living. Accumulation Strategies All the strategies and guidelines which we follow to accumulate money for various goals remain applicable for creating retirement corpus as well. The idea is to accumulate as much money as possible, while remaining true to the client’s risk profile and money philosophy. The strategies we will focus will be applicable during the accumulation period, and throughout the retirement distribution period. There is Micro Level (Client Level) and Macro Level (Economy, Industry level) changes taking places on an on-going basis. Client situations and goals change. Investment returns change. Inflation rates and cost-of-living percentages change. Expenses change. Most of life, and especially financial life, is in a more-or-less constant state of change. For example, we may assume of a 5per cent inflation rate and a 9% average annual rate of return while planning for retirement goal but actual return and actual inflation may vary calling for review of portfolio every year at least. I always suggest evaluating portfolio created for any financial goal at least every 6 months. . I am sure you remember standard deviation? Standard deviation identifies the degree to which returns vary from the mean or expected return. While standard deviation has several applications, one is related to both accumulation and distribution of retirement funds. Especially in an investment with high variability, the environment in which an individual deposits or withdraws money has a great impact on the size of the accumulated funds. All things being equal, lower standard deviation is better than higher standard deviation. This will become especially relevant when we look at portfolio distributions and sequence risk in a later chapter. Accumulation calculations are often made assuming consistent returns. And the forecasts are almost always based, to some degree, on historical returns. Historical returns are ok to create base but future returns and risk may be different calling for need to review regularly. CFP Level 2: Module 1 – Retirement Planning Page 10

Monte Carlo analysis, named after the gambling centre in Monaco, is a probability simulation model that, in simplified terms, attempts to analyze and synthesize a large number of prior-year investment returns. It then runs repeated simulations to determine how likely it is for a particular outcome to result from the inputs. The analysis includes a range of possible future outcomes based on a very high number of randomly generated processes, which explore quite a few different scenarios. When used with retirement planning portfolios, Monte Carlo analysis attempts to estimate not only how much money an investor’s portfolio may accumulate, but also how long the money will last. A Monte Carlo analysis will incorporate inputs, such as interest rates, number of years until retirement, spending plans (goals and habits), portfolio make-up and diversification, along with anticipated years living in retirement. From these data points, the analysis will project the likelihood that a client will achieve retirement financial goals (Paul V. Sydlan sky, 2017). The following chart (Kitces, Monte Carlo Analysis, 2017) shows an example of what a Monte Carlo simulation can look like. While it may appear a confusing mess of lines, it’s actually showing many possible outcomes based on advisor inputs. This analysis does not forecast based on future results based on straight-line investment returns (e.g., large cap stocks will average 10per cent annually year-after-year), Monte Carlo analysis reaches back into history to capture actual returns over many given periods. As an example, rather than simply using a consistent +12per cent annual return, the analysis will identify that one year the return was -10per cent, the next it was +30 per cent. The two returns average 10 per cent but not as an annual 10 per cent return would forecast. With this scenario, rather than a 10 per cent return on Rs.1, 000 over two CFP Level 2: Module 1 – Retirement Planning Page 11

years resulting in Rs.1, 210, the analysis will show a two-year return of Rs.1,170. (Rs.1000* (1-10%)= 900, (Rs.900 *1+30/100= 1170) If we take average return of 10% p.a. for 2 years it will be=(Rs.1000*1.10*1.10= 1210), it can also be done using CMPD function in your calculator-CASIO FC200V. That Rs.40 may not seem like much, but over a 25 or 30-year period the variance can make a big difference, especially in the distribution phase of a retirement portfolio. Run that type of scenario thousands of times to reflect 30 or more years of returns and you can begin to see how Monte Carlo analysis can provide valuable information. In that respect, it is a useful tool. But we need to understand that Monte Carlo analysis may be a useful tool, but it has a significant problem. It depends on the provided data, and we have already seen how past returns do not necessarily reflect future results. Mutual Funds also come with a warning that past returns do not predict future returns accurately. There is no way to incorporate all the variables that may arise. Just as no one can accurately predict future market results, it is impossible to know what will happen to the client’s financial or personal situation, the economy, government and taxes, health and technology developments, etc. over time. You can run thousands of Monte Carlo iterations, and still not be any closer to predicting actual future returns. However, Monte Carlo does help develop guidance as to probabilities that a client may or may not achieve future investment goals, especially when paired with historical return data. It will not accurately predict future investment results, though. An advisor who runs a Monte Carlo analysis for a client will be able, based on the software’s built-in assumptions and advisor input, to tell the client the likelihood that he or she will succeed or fail in the attempt to reach a goal (both the accumulation and distribution sides). An advisor, for example, might be able to tell a client that he or she has a 70 per cent chance of success (which unfortunately, also means a 30 per cent chance of failure). From a theoretical standpoint, this means that in 70 per cent of the analytical iterations, the client would achieve his or her goals. Also, in 30 per cent of the iterations, there would not be enough money to fully fund goals. Such a scenario misses several key points, as Curtis further articulates:  Monte Carlo assumes that the plan never changes during its full span. This is unlikely to happen, assuming the advisor does his or her job and includes annual reviews in the planning process.  Clients in retirement tend to become more conservative as they age.  The projection does not say anything about the degree to which the portfolio failed. A small shortfall is counted the same as a large one. Failure is failure to Monte Carlo.  The projections only consider whichever portion of a portfolio the advisor includes. Other cash flow sources will have an impact on the client’s ability to maintain cash flow throughout retirement. CFP Level 2: Module 1 – Retirement Planning Page 12

In his writing on Monte Carlo, Curtis recommends an alternative or additional analytical tool of stress testing the portfolio. He identifies five core steps in the process:  Help clients create a picture of their goals.  Create a base plan using average returns.  Stress test the client’s plan for return-sequence risk and unsystematic risks.  Repeat steps 2 and 3 as necessary to create an effective plan.  Apply Monte Carlo analysis to compare results if it is helpful to a client. Stress testing includes considering things like bad timing (e.g., sequence of returns). By this we mean that sometimes an investor may experience particularly bad results for an extended period of time, because of a certain economic cycle. If this happens at the beginning of retirement, it can cause long- term difficulties. Of course, the reverse is also true, and clients can sometimes experience results that are far better than they expect. When stress testing a portfolio, advisors can evaluate potential return scenarios, based on historical data, to show the impact of asset allocation, market returns, timing and amounts of deposits and withdrawals, and the like. A stress test also can incorporate significant events, such as the global economic meltdown during the 2007, 2008 period. Some firms have proprietary software for stress testing. Advisors also may run a Monte Carlo simulation to review stress testing scenarios. Sustainable Investing Keeping in mind the risk profile of investor, asset management and investing must first focus on goal achievement. The goal should not get lost in the effort of accumulating as much money as quickly as possible. This is unfortunate, because focusing only on accumulating as much money as possible usually results in a strategy shift, which may result in losing money rapidly rather than accumulating it. One should not chase returns to structure a retirement planning (or any other) portfolio. As Russell Investment’s Don Ezra (Global Director Emeritus, Investment Strategy) wrote, “Since I retired, I’ve come to the conclusion that the standard measure of success for retirement investing is virtually irrelevant to me and other retirees. Investment managers often spend their entire careers chasing time-weighted excess returns – also known as alpha. But retirees can’t eat time-weighted returns When a person starts accumulating for retirement, the time horizon to achieve goal is long term so investment should be made in equity through Mutual Fund route but as time to retirement approaches near, slowly a shift towards some portion in debt and then more portion in debt as time comes closer further. Let us take an example to explain this. A 30 year old starts investing Rs.10000 p.m. to accumulate retirement corpus. Since time horizon is very long term, he should invest all amount in equity. As he becomes 50 years of age, he should slowly start transferring some investments in debt CFP Level 2: Module 1 – Retirement Planning Page 13

funds so that by the time he reaches retirement age at 60, 40% is transferred to debt or may be 50% is transferred to debt. When we plan for retirement we always look at the present cost, inflation rate and future cost. Inflation will be there after retirement as well. Return on investments after paying taxes and meeting inflation need to be in positive territory. Client Attitudes and Financial Education When you meet a client to help them make their retirement plan, you may find lack of financial knowledge leading to different attitudes towards various asset classes. As we all know, with having better financial education, risk appetite of clients also improve as earlier they were not aware of many products and their risk return attributes. You cannot fault people for their investing behaviour, but you can educate them so they take a better approach. It’s good to remember that the average person is exposed to quite a bit of financial information – much of which is biased, irrelevant or invalid. A good financial advisor will include an element of education when working with clients. Your clients will benefit greatly from your unbiased information and guidance. What kind of education should you provide? You have to be careful and make sure clients understand that past performance is no guarantee of future results. If they understand that truth, then you can provide some historical return information for perspective. You can also develop sample portfolios to show theoretical results. Now, let’s look at returns from eight asset classes over time arranged from least risky to most risky (Deutsche Bank AG, 2015)[7]. Asset Class – Index Best Worst Cash 4.7% 0.0% High Grade Bonds 7.84% -2.02% Large Cap Value Stocks 38.36% -36.85% Commodities 31.84% -35.65% International Stocks 38.59% -43.38% Large Cap Growth Stocks 38.71% -38.44% Small Cap Growth Stocks 48.54% -38.54% REITs 36.74% -37.97% CFP Level 2: Module 1 – Retirement Planning Page 14

Except for cash, each asset class has had at least one year of negative returns. As you might expect, bonds had the least negative return other than cash. Think through the variability of each class based only on the information presented. You may reach two conclusions from this data. First, you never can guarantee positive returns every year. Second, if you built a portfolio of different asset classes and weights, you would decrease the maximum potential annual return, and you would also improve the worst return relative to overall performance. Specifically, if we built a portfolio based on 15% large cap stocks, 15% international stocks, 10% small cap stocks, 10% emerging market stocks, 10% REITs, 40% high-grade bonds, and used annual rebalancing, here would be the results. Asset Class Annual Best Worst Asset Allocation Portfolio 8.73% 25.9% -22.4% Information such as this may help clients understand both the variability of all investment options and the need to diversity and stick with their retirement plan even during times of volatility. CFP Level 2: Module 1 – Retirement Planning Page 15

Chapter-2 Retirement Objectives Learning Outcomes Upon completion of this chapter, the student will be able to:  Identify a client’s retirement objectives  Evaluate the implications of a client’s attitudes toward retirement  Evaluate trade-offs needed to meet a client’s retirement objectives  Calculate capital required to fund a client’s retirement Topics  Retirement goals and objectives  Goals and needs  Capital required for retirement  High net worth clients  Establishing retirement cash flow targets  Conflicting goals and trade-offs  Objectives in retirement  Wealth transfer Introduction: It is essential to start saving and investing as early as possible for your retirement. The best opportunity for someone to do this is when they finish their education and start a full time job. The change in income is usually very large at this time and it is possible to save a good percentage of income while still upgrading their student lifestyle. Many new college graduates have loans, but they can pay these off slowly while saving and investing for retirement at the same time. CFP Level 2: Module 1 – Retirement Planning Page 16

Employers Provident Fund: Most of the employers have EPF plan that a new employee has to compulsorily join. The money is automatically deducted from their salary before tax and it often isn‘t even missed. EPF also has employer matching, typically 10 to 12% percent of salary, and the employee should take full advantage of this. At the very least, you should start saving for retirement by contributing up to the matching amount. EPF is an automatic and significant saving plan. Rupee-cost averaging and compounding: New college graduates have decades of work ahead of them and it‘s easy to put off saving for retirement until later. However, it is much better to start saving right away to take advantage of rupee-cost averaging and compounding right from the beginning of your career. The stock market historically performs very well over the long term and even the current volatility is great for rupee-cost averaging. When the market drops, your contribution buys more shares. If you have 30 years left in the workforce, you can ignore the day-to-day market fluctuation and keep buying. The earlier you start saving for retirement, the longer your retirement account will have a chance to compound and the more you will have for retirement. Start investing early in your career and it will become a habit. By saving for retirement as soon as you start working, you will spend less money overall and learn how to invest. In 30 years, your retirement account will be in much better shape than most of your colleagues. Suggestions to plan early for retirement: 1. Take the saving decision out of your hands: People don‘t fail to plan for retirement because they don‘t believe it‘s important. It‘s because saving doesn‘t come naturally to most of us. Part of our brain is hard- wired for immediate gratification. And even if you possess the willpower to forego pleasure today for a payoff tomorrow, exercising it on a consistent basis can be a tough considering that affording even the necessities can be a challenge these days. Many fund companies allow you to start such a plan with a few hundred rupees every month. Mutual funds allow you to invest small amounts regularly and give good returns on long term savings. You get the benefit of rupee cost averaging and power of compounding. Rs.1000 saved per month for 30 years @ 15% p.a. will become Rs. 70 lakhs assuming compounding to be monthly. If you get a higher return say by 2%, you will be able to accumulate Rs. 1.11 crore. There are few schemes of mutual funds which have given higher return than this consistently. 2. Don‘t get bogged down by details: Despite good intentions, some people never get around to starting a retirement plan because the whole process just seems too complicated. Deciding how much money to put away, which investments to choose how much to invest in each one...The number of choices can feel overwhelming and lead to paralysis. When you start working, you open a PPF account and your EPF savings will also support you. You should also start small amount in Equity Oriented Mutual Fund scheme. CFP Level 2: Module 1 – Retirement Planning Page 17

3. Keep the momentum going: Good investing can help build your nest egg, but the surest path to a secure retirement is regular saving. So as you progress in your career and earn more money, try to increase your savings effort as well. Once you‘ve got your retirement plan underway, you can always change or refine your choices later. You can re-assess how much to save, revise your investments and monitor your progress .But if you never take the first step, you won‘t have anything to change or refine. Except perhaps your retirement plans, which you‘ll have to down Planning for retirement is a long-term project, involving many steps and using a number of tools. The process, while multifaceted, can be simplified to relatively few steps:  Establish and define the relationship with the client(s)  Gather pertinent data  Analyze the data to determine the client’s current status  Develop and present recommendations  Implement solutions (or provide guidance for implementation)  Monitor progress (depending on the nature of the engagement) An advisor can focus mainly on two steps:  Gather and analyze pertinent data  Develop, present, and implement recommendations to address the client’s concerns If a client retires with an average life span of an additional 20 years or so, they will have a long time to live, with no ready source of cash flow with the exception of any government, or employer-sponsored pension. A pension may or may not provide enough cash flow to maintain a retiree’s desired lifestyle. A worthwhile question is, “could you live comfortably for the next 20–30 years on only the cash flow provided by your pension?” For many people, the answer will be no. Yet, at the same time, people often believe they will be financially comfortable in retirement. Partially as a result of this thinking, they often do not make reasonable plans for retirement. Without adequate funding, retirement can mean living in difficult financial circumstances, with the fear that even limited financial resources will not be enough. In too many situations, retirees will, at best, have an existence where any unanticipated expenses can do significant harm. The good news is, a relatively simple solution exists to prevent this scenario. Plan, save and invest. By saving and investing wisely after evaluating what retirement might look like (e.g., desired lifestyle, available resources, medical concerns, etc.), one can address many pre-retirement concerns. CFP Level 2: Module 1 – Retirement Planning Page 18

Retirement Goals and Objectives Role of Financial Planner in Retirement Planning: A qualified financial planner does the following:  Helps you find the balance between needs, values, and desires  Ensures that you operate within legislative constraints /compliance  Calls your attention to practical considerations  Sees that your level of risk is appropriate to your situation, using his ability to project into the future  Be of great benefit to you because through training and experience he is able to analyze outcomes Just as you visit your family physician for an annual health check-up, you should demand periodic financial check-ups. Get a financial report at least once/twice a year from your financial planner or advisor and do the same when you experience significant financial changes. The Financial Planner will help you understand how much you need to grow your wealth before you retire and how to plan for it. For ease of use, this tool is divided into four sections. Estimate your cost of living in retirement, the investment returns required and the financial wealth you need to build, prior to retirement. Also, arrive at a personalized savings plan. Step 1: Estimate your cost of living in retirement: In this section, you need to first estimate what your expense profile is likely to be when you plan to retire.  What is your current age?  At what age do you plan to retire?  What‘s your Current Monthly Expense Profile?  Current Expenses Calculator  Inflationary Expenses (per month)  Non-inflationary Expenses (per month)  What % of these expenses do you expect to incur when you retire  Inflationary Expenses  Non-inflationary Expenses CFP Level 2: Module 1 – Retirement Planning Page 19

 Estimate the annual inflation rate from now until Step 2: Estimate investment returns needed This section will help you calculate how much investment income you will need in order to meet your cost of living when you retire  What % of these expenses will be met from sources besides your retirement fund? Step 3: Compute wealth needed prior to retirement  Compute what level of financial wealth you need to fund your retirement expenses by the time you are retired.  What annual pre-tax return do you expect your financial wealth to earn?  What is the average tax rate you expect to pay on investment returns in retirement?  What rate of inflation do you believe will prevail in the years of your retirement Retirement lifestyle changes have significant potential for increasing retirement expenses. Here are some questions to explore with the client: a. What does retirement look like to you? b. How do you see yourself spending time in retirement? c. How much do you plan to travel? d. Do you plan to make major changes, such as starting a business, getting adegree, or remodelling your home? e. What is it that you have always wanted to do and now will have the time to accomplish? From this point, you can begin to quantify those plans and dreams. Consider the goal of getting a degree  What field of study?  Full-time or part-time (how long will it take to complete the program)?  Which college or university?  Undergraduate or graduate?  Are there internship and/or residency requirements?  Will this lead to new career opportunities? With this information, you can determine the cost of getting the degree along with the potential overall financial impact. As mentioned above, it is not uncommon to find that financial realities are at cross-purposes with a retiree’s dreams. This does not mean that the dreams cannot be realized. It does, however, require a more in-depth evaluation of their budget. CFP Level 2: Module 1 – Retirement Planning Page 20

Let’s assume that the new graduate degree will cost 5,00,000 and that the client wants to take the money from savings. What impact will this have on available resources for a retirement budget? Let’s assume that this retiree has accumulated assets of Rs.75,00,000. If we assume a 30-year life expectancy, a three per cent inflation rate, and a long-term rate of return on assets of seven per cent, we get an annual inflation-adjusted cash flow from assets of around Rs.410,000 (rounded, and using real(3.8834%), rather than nominal, return). By eliminating Rs.5,00,000 up front, potential annual cash flow is reduced to a little more than Rs.27,000. Not a big difference, but indicative of how dream fulfilment can impact the long-term financial picture. You can see how the fulfilment of even one dream can have a budgetary impact. If the individual has quite a few dreams for retirement, the financial implications can start to add up. When trying to determine a retirement budget, understanding an individual’s goals and dreams—and related costs—is a significant step in the process. Inflation Inflation, and its impact on purchasing power, is among the most significant factors to consider when doing a retirement needs analysis. The cost of a basket of groceries will just about double in 14 years with an average inflation rate of five per cent. Let’s explore some of the long-term implications of inflation as it relates to a retirement budget. Financial advisors recognize that money today will not have the same purchasing power in the future. Unfortunately, not all of the advisor’s clients recognize this fact. Too many people seem to think that they can plan their retirement budget on a straight-line basis. Meaning, if it costs Rs.50,000 a month to live today, it will cost the same 25 years from now…and they plan accordingly. The financial implication of this can be profound. If you plan to have enough money to fund a Rs.50,000 per month budget for 25 years of retirement, and you can earn a seven per cent return (compounded monthly), you would need a little more than Rs.70,00,000 to fund a retirement budget if you do not include an inflation factor. However, once you add the inflation factor, you would be significantly underfunded. Instead of around Rs.70,00,000, you would need a little less than Rs.1 crore to maintain an inflation-adjusted budget with equal purchasing power (using an inflation-adjusted [real] rate of return of 3.8835 per cent compounded monthly). That close to Rs.30,00,000 shortfall would result in a significant decrease in standard of living as you advance through the later stages of retirement. To make up the inflation factor shortfall, you would have to adjust your retirement savings plan. To accumulate Rs.70, 00,000 over a 25-year period, at a seven percent rate of return, requires an annual investment of approximately Rs110,670 (end of year investment). To accumulate the more than Rs.96, CFP Level 2: Module 1 – Retirement Planning Page 21

00,000 necessary to deal with the inflation factor requires about Rs.1, 51,780—Rs.40, 000 a year increase. Without compensating for inflation, toward the end of the retirement period, a time when healthcare expenses can be expected to be at an all-time high, your purchasing power would decrease to around half of what it was at the beginning of retirement. Greater expenses coupled with diminishing cash flow (purchasing power) are not a recipe for a comfortable retirement. Healthcare Issues People are living longer now because of improved health facilities. There are problems associated with this increased longevity. Problems range from outliving financial resources to outliving friends and family to significant lifestyle changes. One of the most common areas of concern centers on the potential increased cost of healthcare for seniors. Even the most positive and upbeat commentator is unlikely to deny that a looming healthcare problem exists as a result of people living so much longer. The increased potential cost of healthcare as one ages is significant. How significant? According to a study by Fidelity Investments (a U.S.-based mutual fund company), a couple reaching age 65 who live to a normal life expectancy (around age 82 for males, 85 for females) can expect to have medical expenses in retirement of around $260,000. This amount identifies costs in excess of what is covered by Medicare (the U.S. government healthcare program for seniors) (Fidelity Benefits Consulting, 2016). While the Fidelity study references costs in the U.S., OECD shows increasing healthcare costs in many member territories (OECD, 2017). Expenses tend to be lower in non-US territories, but they still can represent a significant part of a retiree’s financial exposure. Based as a percentage of GDP, healthcare expenditures in most territories approach or exceed 10% (Commonwealth Fund, 2017). Given global movements away from, or decreasing, government-provided social security benefits, covering these expenses should be part of the retirement planning discussion. Whether or not those forecasts match each client’s reality, or fully applicable in all countries, it’s clear that healthcare expenses have the potential to consume an increasing portion of a person’s retirement assets. When you factor these expenses into the average retiree’s financial picture (remembering that many people have not saved nearly enough money), the picture does not look very positive. This may especially be true when you consider that many countries are decreasing retirement and healthcare- related benefits as a result of budget cuts. What can be done to deal with the healthcare expense problem? While planning for retirement, along with health insurance policy, some extra provision to be made for health related expenses not covered by health insurance policy. The person shall begin early incorporating the need for increased healthcare funding into planning solutions. For those closer to retirement, viable options depend on CFP Level 2: Module 1 – Retirement Planning Page 22

their financial status, including the amount of assets they have accumulated, along with available discretionary cash flow. Capital Required for Retirement What components must be included to develop a retirement cash flow budget? We have already looked at some of these, and will go into greater depth in chapter 3. For now, we will explore the component parts to be included when calculating required capital. To do this correctly, the financial advisor and client will need to assess current spending, anticipated increases, and retirement cash flow amounts already accumulated. Using a spread sheet or computer program/app will be helpful. You can also use a pen and paper if preferred. The format is less important than capturing complete information. Since we do not have specific inputs yet, we will assume some numbers. Annual living expenses: Rs.6, 50,000 Annual healthcare expenses: Rs.1, 50,000 Annual travel expenses: Rs.1, 00,000 Annual special purpose expenses: Rs.1, 00,000 (this can be for education, charitable contributions, business development, etc.) Total annual expenses: Rs.10, 00,000 For this hypothetical situation first-year annual expenses total Rs.10, 00,000. Some of the amounts can be modified when needed, but this is a good starting point. If the annual need is Rs.10,00,000, we need to plan for a given number of years, agree on an inflation rate and determine an acceptable rate of return. Let’s use 25 years for the retirement period, three percent inflation and seven percent discount rate (investment rate). The real (inflation-adjusted) rate of return is 3.8835. As a reminder, the equation to arrive at this rate is: Using the real rate to determine the amount needed at the beginning of retirement (using a financial function calculator), the keystrokes are:  25 N  3.8835 I/YR CFP Level 2: Module 1 – Retirement Planning Page 23

 10,00,000 PMT  PVAD = Rs.16430460 (PV) This assumes the Rs.10,00,000 is the actual first-year payment and does not need to be inflated as a first step. The point of this exercise is not simply to settle on one correct number. Instead, we want to see how living, medical, and additional expenses can significantly increase amounts needed to fund retirement. If you only use annual living expenses of Rs.6,50,000, the amount needed drops to just a little over Rs.1 crore. Unfortunately, that’s not a realistic approach, and should not be used. Why? Retirees will almost certainly expand activities, and will incur increased medical expenses as they move further into retirement. Even when many medical expenses are covered by social security plans, there likely will be additional expenses related to on-going healthcare. All these additional activities and financial outlays will increase living expenses. As such, it will be better to plan for increased expenses rather than assuming nothing additional. Example Question Sudha wants to retire in seven in years. In today’s terms, the client believes she will need an additional Rs.6,50,000 lump sum in today's terms in a addition to her guaranteed pensions to have sufficient funds to finance her b retirement. You and your client assume inflation will average 3.5 per cent c over the long run and that the client can earn a 10 per cent annual return d on investments. What inflation-adjusted payments are required to be Correct Answer made at the beginning of year starting immediately in order for the client to achieve her goal? Explanation Rs.70679 Rs.72,224 Rs.76,851 Rs.76,627 B To maintain purchasing power, the negative impact of inflation must be addressed. ((1.10/1.035) −1) ×100=6.28019. Mode = BGN, P/Y = 1,C/Y=1, N = 7, I = 6.28019, PV = 0, FV = 65,000 (we adjusted the I/Y for inflation), CPT PMT = -7,224.18136 CFP Level 2: Module 1 – Retirement Planning Page 24

Distractor #1 a Mode = END Distractor #2 c I= 10 not inflation adjusted Distractor #3 d I = 6.5 (10 - 3.5) High Net worth Clients Let us understand the needs of high net worth (HNW) clients. In many ways, their needs will be similar to individuals with lower net worth amounts. However, with greater amount of assets come increased needs and opportunities. Most of this course is focused on helping individuals of average financial means achieve their retirement cash flow objectives. With average group, retirement needs primarily fit into the category of having enough cash flow to fund regular expenses along with any additional items unique to retirement. HNW individuals generally do not have the same concern. There will be exceptions, but generally, HNW individuals have enough money to fund all normal expenses. At the same time, it’s important for the financial advisor to understand that even HNW individuals can struggle to match spending with available assets, leading to a potential cash flow gap. Also, with many HNW individuals, part of the planning process must include answers to the question, “What should I do with assets I do not require to meet my retirement lifestyle needs?” Further, many of the rules impacting individuals with average cash flow and net worth (e.g., government programs, income tax regulations, asset distribution), are relevant for HNW individuals. Cash Flow Gap in case of High Net worth Individuals This is not true for all HNW individuals, but some are not able to keep track of their cash inflows and outflows. During their earning years, HNW individuals focus on building their asset base – via businesses, real estate acquisitions and active investment trading and similar activities. The date of their retirement can be anytime, but when it occurs, many of their asset-building activities cease. However, their lifestyle may not change all that much. As a result, HNW individuals can struggle with the same problem as everyone else – matching retirement lifestyle with available assets and related cash flow. Unless an individual is in the ultra-HNW category, even a HNW person can run out of assets as a result of excess spending. When working with a HNW individual, one of the first objectives is to develop an accurate assessment of assets and typical expenses. Remember, too, that the additional retirement expenses previously covered can also impact HNW individuals. Keeping all this in mind, the financial advisor should do an analysis to determine the degree to which available assets can support their CFP Level 2: Module 1 – Retirement Planning Page 25

desired lifestyle in retirement. If existing funds can fully support their desired lifestyle (along with enough margin to have a safety net), no changes may be necessary. However, it’s possible that assets will not support lifestyle, thereby creating a cash flow gap. When this is true, advisor and client will have to discuss adjustments to bring their target retirement lifestyle in line with available assets. Actually the discussion about available cash and needs should happen many years prior to retirement. This way, when analysis shows a potential cash flow gap, the HNW individual will have sufficient time to increase assets or make pre-retirement lifestyle adjustments. One of the potential problems HNW individuals face does not understand the need for assets to generate sufficient cash flow to support their retirement lifestyle throughout the rest of their lives. Balancing asset-generating cash flow with sustainable withdrawal/distribution rates is as important for this group as it is for everyone. HNW individuals also face few problems when they retire. They need to develop a plan to care for dependents – including elderly parents and children. They consider philanthropic/charitable activities. It may be that HNW individuals have more money available to distribute, but it should be distributed wisely and in keeping with their objectives. HNW individuals need to help their children learn how to handle wealth responsibly. This is one aspect of being a HNW individual that differs from others. A concern faced by many, including HNW individuals, is how best to pass on assets. In many cases, children of HNW parents (especially minor children) will be faced with large amounts of money that will require education to help them know how best to manage the funds. The estate distribution, legacy and generational wealth transfer arena is addressed in FPSB’s Estate Planning and Wealth Transfer course, but it is a consideration when doing retirement planning. The financial advisor should plan to have an open discussion with HNW clients about what they want to accomplish and how to do it. Although you might think you can skip basic steps with HNW individuals, doing so will be a big mistake. They should go through the same process as other clients planning for retirement. This means the first step will be to determine a desired retirement lifestyle and the money that will be required. They may have greater options than others, but the needs will be similar. Add to this the need to incorporate estate distribution and lifetime gifting concerns. These will need to be coordinated. You need to see that right amount of money is available at right time, so discussion regarding same is required to be done with HNW clients as well. Many HNW individuals have portfolios that include a larger than normal amount of illiquid investments, such as businesses, real property, partnerships and the like. These may be good options to generate investment returns, but not so good at providing retirement cash flow. Reallocation of at least a portion of the investment holdings can be worthwhile. The bucket system may be helpful. Simply put, the bucket system (introduced in the Investment Planning course), separates assets into three buckets. CFP Level 2: Module 1 – Retirement Planning Page 26

The first bucket holds one or two years’ worth of cash equivalents. This is money they will use for living expenses, and must be liquid and stable – Flexi deposit accounts, money market instruments, savings accounts, Bank FD etc. The second bucket can make up the bulk of this bucket, along with stocks (preferably dividend-paying) of well-developed, strongly managed companies, bonds, schemes of mutual funds etc. (The money will be used between 3rd and 7th year) The final bucket can house investments that have greater volatility, because they will not be accessed prior to seven years in the future. Into this bucket can go the majority of illiquid investment holdings? As funds are removed from the first bucket, replace them with funds from the second bucket. These, in turn, will be replaced with funds from the third bucket. This means that, to whatever degree necessary, the HNW client will need to consider which investment holdings should be (or can be) liquidated to provide more easily-accessible cash flow. Some of the holdings, such as businesses, may generate regular cash flow on their own, and will not need to be liquidated. Just use the income to replenish the first bucket. Ultimately, if the HNW individuals live long enough, or cash flow needs are high enough, the third bucket may be empty, but if there are enough accumulated assets, this may not ever happen. One of the interesting philosophies of many HNW individuals is that they dislike too much volatility. As a result, you may need to do two things. First, temper the degree to which money in the third bucket is invested in risky assets. If there is enough money, these clients will have no need to move too far out on the risk spectrum, and may actually be unwilling to incorporate much volatility in their investments. This is the second area for you to address. You will need to suggest that the clients use the third bucket wisely and plan for the portfolio to continue growing throughout their retirement period. It will be helpful at this point for you to review the content from FPSB’s Asset Management and Investment Planning course. Having a good understanding of the concepts in that course will prove beneficial when doing retirement planning with all clients, and especially with HNW individuals. Establishing Retirement Cash Flow Targets Normally when a person retires, the expenses of couple come down as work related travelling and other expenses are no more. Retirees need only 60 to 80 per cent of pre-retirement cash flow. This higher amount is required initially, but this amount will decrease as retirement advances. It may be true in cases of some people but in others may be health related expenses leading to changes in lifestyle may increase. Most of the retirees do expect to reduce spending in retirement. According to a recent study by the Employee Benefit Research Institute (EBRI) in the U.S., 65 per cent of people surveyed expected their spending to be lower in retirement (EBRI, 2017). Unfortunately, the report goes on to say that 55 per cent of actual retirees find their financial situation to be worse than anticipated, requiring them to CFP Level 2: Module 1 – Retirement Planning Page 27

continue working in some capacity to make ends meet and keep healthcare benefits. Anecdotal evidence also points to retiree spending being higher than expected. Additionally, healthcare costs can add significantly to anticipated expenses, as can things such as needing to make substantial home repairs, having to purchase a new vehicle or major appliance, or similar. Travel and other leisure pursuits can also add to funding requirements. All of this points to the need to realistically assess and forecast (as accurately as possible) all financial factors. Changes made to any assumptions can have a big impact on funding requirements. Trade-offs Necessary to Meet Retirement Objectives Some people have all the financial resources needed to put all parts of a financial strategy into place at the same time. This is one reason why advisor-client relationships often last for decades. Many of the compromises require making lifestyle changes to have the money to achieve goals. This is often true when planning for retirement. We will explore potential trade-offs, and why they may be necessary, next. Balance The word balance means the ratio of time period in accumulating wealth (Period before retirement) versus the time period that wealth is spent (post retirement period). Today we see shorter accumulation and longer expenditure/distribution phases because of increasing longevity, prosperity and early retirements. This means individuals are under pressure to create enough financial resources during shorter working span to fund longer and more active retirement years. Complexity Personal savings patters are significantly affected by:  Increased family responsibilities that may span several generations  The shift from defined benefit to defined contribution retirement plans In the joint family structure, increased longevity has created more financial responsibilities for individuals who are sandwiched between children (or grandchildren) in college and aging parents (and/or grandparents). The expenses of added family responsibilities often affect these individuals’ ability to save for their retirement, and may require them to use portions of their existing retirement assets to pay for family members’ educational, care giving, health and medical needs. In addition to a change in the proportion of wealth accumulation and expenditure periods, and the changes in family needs, we can identify three distinct phases within retirement: CFP Level 2: Module 1 – Retirement Planning Page 28

 Active: Characterized by increased leisure-time activities, such as travel;  Passive: Usually accompanied by a “settling down” with less travel and a greater awareness of end-of-life issues; and  Final: Often a time of having health problems, resulting in increased medical expenses. Today’s retirement patterns reveal great diversity in lifestyles, opportunities, challenges and financial needs. Someone who retires at age 65 may easily live 25 or 30 years (or more) in retirement. Financial needs will vary greatly over that timeframe. Most Important Period We can say that the five years before and the first five years after retirement begins may be the most important in determining a retiree’s overall retirement comfort. People have the highest earning levels just prior to retiring and many major expenses, such as paying off home loan, children’s education, marriage etc. have been taken care of, creating a higher surplus to invest more amount per month. That's the positive part, says Michael Stein, a certified financial planner professional in Boulder, CO (US), in his book, \"The Prosperous Retirement\" (Emstco Press, 1998). The negative side is something he calls \"lifestyle creep.\" This boils down to the old idea that when you have money you spend it. Pretty soon you're so used to spending that it seems as if it's a sacrifice to spend less. As a result, you require a bigger nest egg to keep you in the style to which you have become used to. Even I have observed people spending lavishly and not caring much about accumulating adequate amount of corpus (nest egg) for retirement. During retired phase, they have to make compromises. The first five years following retirement have the potential to become a second childhood, Stein says. Healthy seniors with considerable nest eggs can start to spend like there is no tomorrow – or at least as if their money doesn't have to last several decades. The typical 65-year-old can expect to live almost 20 more years. \"We call it the decision decade,\" says Christopher Price, senior vice president of insurance products at Delaware Investments in Philadelphia, PA (US). Make the right decisions in that 10-year period and your money will probably last as long as you do, ensuring a comfortable – although sometimes modest – retirement, Price says. Make the wrong decisions and you could easily outlast your cash. So, what are the right things to do if you haven't saved much and retirement is looming? You need to invest huge amount per month. If you have a few years of employment ahead and you find yourself in the fortunate position of having extra discretionary cash flow, save it – all of it. A family CFP Level 2: Module 1 – Retirement Planning Page 29

with a spouse re-entering the work force while the other simply gets regular raises could conceivably save one-third of the money needed for retirement in just five years, Stein says. They can do that by saving the bulk of the additional cash flow they earn, including all of the second spouse's take-home pay. That not only boosts their savings dramatically, it also prevents them from raising their living standards right before retirement. Stein’s assertion of living 20 years into retirement understates potential reality. However, that makes Stein’s recommendation even more important. The five years preceding retirement should be a time of saving as much money as possible and the five years following should not be a time of excess spending. Rather, new retirees should exercise prudence during this period as they determine appropriate spending levels based on accumulated assets. This discussion leads us to conclude that people shall consider potential lifestyle changes to help during the 10 years that span just prior to and immediately following retirement. Behaviourally, making these changes can be especially difficult. People get tired of sacrificing, and as they approach retirement, they often want to increase spending. Stein identified this as “lifestyle creep,” and it can negatively affect a person’s entire retirement. Let us take an example to understand how increasing savings in 5 years before retirement can lead to having a bigger corpus than going ahead with normal savings throughout. Mr. Arora started investing Rs.1,00,000 p.a. 20 years back when he was 35 years old. Average Investment return is 12% p.a. Now he is 55 years old and has no responsibilities of home loan payments, education of children and marriage of children. He has now more income at his disposal to invest and he has increased the investment amount to Rs.5,00,000 p.a.. Let us take two situations and see the difference in amount as he has become very much focussed to invest more money in the last 5 years. He has not increased his discretionary expenses. Let us assume same rate of return in the last 5 years as well. Solution: When he continued investing Rs.100000 p.a. When he invests Rs.100000 p.a. up to age 55 till he is 60 years of age and increases to Rs.500000 in last 5 years. -100000 PMT Step-1 Beg Mode -100000 PMT 12 I Beg Mode CFP Level 2: Module 1 – Retirement Planning Page 30

25 N 12 I P/Y=1 20 N C/Y=1 P/Y=1 Solve FV= 1,49,33,393 C/Y=1 Solve FV= 8069873.55 Step-2 -80,69,873.55 PV Beg Mode -500000 PMT 12 I 5N P/Y=1, C/Y=1 Difference in amount = 1,77,68,895 - Solve FV= 1,77,68,895.01 1,49,33,393 =28,35,502. In the first 5 years after retirement, he will keep control on discretionary expenses also, the Introducing Sam Let’s assume Sam makes $30,000, average annual after-tax income. With an average cost of living, Sam is not likely to be saving much for retirement. As Sam grows in his career, and earns more money, he will be able to start saving, but not much at first. It’s likely that Sam will have many years where inflows and outflows are close to evenly matched. Toward the end of his career, if Sam is typical, he will have his highest earning years. In fact, let’s assume his annual income has increased from when he started working to $80,000. Sam now has a choice. He can either start playing or he can continue to increase his savings. Many people in Sam’s position want to start buying cars, boats, jewellery, etc.). If Sam does that, he will forfeit retirement-cash flow potential. To illustrate, let’s say that during the five years preceding CFP Level 2: Module 1 – Retirement Planning Page 31

retirement, Sam is able to either spend or save $20,000 each year. What difference would the $20,000 annual increase in savings at the beginning of each year over the five-year period make to Sam’s retirement cash flow? If we assume a seven per cent investment return, and a 3.5 per cent inflation rate, here’s what Sam would be able to accumulate.  5N  7 I/YR  {0 PV}  20,000 PMT  FV = 123,066 [BEG] During the five years, Sam would have accumulated an additional $123,066. If we plan for a 30-year retirement period, that $123,066 would provide an additional $6,377 inflation-adjusted cash flow annually.  30 N  3.3816 I/YR  123,066 PV  {0 FV}  PMT = 6,377 [BEG] What difference would an additional $6,377 cash flow (adjusted annually for inflation) make in Sam’s financial life? If we consider that this money is in addition to any government and employer-provided retirement benefits, plus whatever else he had been able to accumulate, the additional $6,377 would provide a nice cushion for Sam. If he needed a new car, the extra funds would likely make the payments. If a major appliance needed replacement, Sam would be able to pay cash. If he wanted to have an extra holiday, he could do so without affecting his normal standard of living. Perhaps Sam wants to give gifts to his grandchildren; he could do so with the extra money. If Sam experienced a time of economic downturn where his investments didn’t do as well as he planned, the extra $6,377 might make enough of a difference so he would not have to dial down his standard of living too much. On the other hand, if Sam had spent the $20,000 each year prior to retirement, he would have none of the above. It’s worth pointing out that Sam’s ability to save the $20,000 each year would depend on previous financial decisions. For example, if Sam had accumulated large amounts of debt, much of that $20,000 would likely go toward debt repayment. If Sam became used to purchasing a new luxury car every two years or so, a large portion of the money would be spent on the cars. As we know, quite a bit of financial advice revolves around behavioral and lifestyle decisions. Sam, and his two potential retirement paths, illustrates this fact. CFP Level 2: Module 1 – Retirement Planning Page 32

However, one big concern remains. Will the money last as long as retirement? In general, by following the plan laid out so far, the advisor should be able to answer the question affirmatively . . . but in many cases, not with absolute 100 percent certainty. There is a way to guarantee that at least a portion of a client’s assets will last throughout retirement, and we will look at this next. Lifetime Security Insurance company have annuity plans for retirees. Many retirees feel comfortable buying annuities to meet their monthly expenses. Some people who understand impact of inflation on cost of living, they do not put the entire corpus in to annuity because returns offered are not able to meet inflation adjusted expenses for a very long time. Depending on the situation and the application, each of those characterizations may be true. First, although it is possible to create what is sometimes called a synthetic annuity, unless there is an actual lifetime cash flow guarantee, the individual cannot be certain he or she will have enough cash flow to last a lifetime. Synthetic annuities come in several varieties, but generally use various types of securities along with derivatives (e.g., option contracts) to address investment volatility and generate a cash flow stream to last throughout the desired timeframe, including the lifetime of the investor. However, unless an insurer issues the investment, and includes a mortality charge based on actuarial analysis, the investor will not have a lifetime cash flow that is guaranteed. “Guarantee” is the key term, and it’s the strongest benefit offered by an annuity (or other insurance company-issued guaranteed- cash flow contract). The lifetime cash flow guarantee is not free, but as long as the issuer remains solvent, the guarantee is good. If the underlying retirement funding goal is to have enough money to last throughout retirement, why not just put the entire individual’s money into an insurance company annuity product? Some people do make that choice, but it’s not always the best option. Cost is one consideration (the mortality and expense [M&E] charges can get rather high). Loss of flexibility is another big concern. As discussed in FPSB’s Risk Management and Insurance Planning course, annuities have two stages. The first stage is the accumulation period, during which the owner can make deposits, and the annuity account grows. The second stage is the annuitization period, during which the contract makes periodic payments as agreed upon by insurer and contract owner. Both stages impose limits on when and how (and at what cost) the contract owner can access money. The annuitization stage is especially rigid. To begin annuitization (i.e., regular payments), the owner technically surrenders the accumulation contract to the insurer so it can be converted to a cash flow stream. Once this happens, no change is possible (with some exception). In most cases, the owner who changes his or her mind about the annuitization would not be able to reverse or otherwise change the decision. CFP Level 2: Module 1 – Retirement Planning Page 33

What does the owner get for agreeing to decreased flexibility and increased expenses? Annuitants have the option to receive a guaranteed cash flow for life. The amount of cash flow is based on the person’s mortality factors, investment returns (the insurer’s or individual’s depending on the contract), expenses, and such. However, assuming the insurer is legitimate and financially sound, the guarantee is ironclad. For many people, this peace of mind is worth the cost and lack of flexibility. We can agree that an annuity has the potential to be a good option, but does it qualify as the best or only option? For most people the answer is no. The loss of flexibility is the primary reason not to use an annuity as the sole retirement-funding vehicle. Having said that, a competent insurer’s representative would likely be able to provide viable suggestions on how to structure an annuity portfolio to increase flexibility while providing the desired cash flow options. The problem, however, remains, that any solution involving annuities would have both cost and flexibility penalties that diminish its desirability for many retirees. If annuities do not provide the optimal solution for 100 per cent of a retiree’s portfolio, do they still have potential application? Yes and the key is in annuitizing a portion of an otherwise-invested portfolio. Rather than think in terms of “either, or”, an advisor might consider a regular investment portfolio “and” an annuity. If an individual annuitizes a portion of the retirement portfolio, that portion will provide cash flow at a guaranteed rate, regardless of what the non-annuity investment market does. The investment market may go through a downturn several times during an individual’s retirement. When that happens, retiree cash flow is also likely to decrease. The guaranteed income generated by an annuity may help stabilize overall cash flow. Further, depending on the payment period chosen, income from the annuity will not stop. As such, annuitizing a portion of client assets may increase the likelihood that a retiree can enjoy a higher cash flow over an extended retirement period. When to annuitize is a good question. The answer depends on the individual situation. Generally, waiting beyond the initial period of retirement makes sense. The one caveat to that being, if a retiree is extremely nervous about future cash flow, and is uncomfortable considering any sort of investment portfolio, annuities may provide a solution. It won’t likely be the optimal solution, but it may provide a desired comfort level. For most other people, there seems to be little reason to purchase an annuity early on. Let the portfolio continue to work and generate the desired cash flow. Maintain flexibility and the option to make changes as the need arises. Then, as the individual travels further into retirement, placing some portfolio assets in an immediate annuity may make a positive addition. The idea of annuitizing part of a retirement portfolio presupposes that the remainder would be invested in other options. One of those options may be something called a target date, or lifecycle fund. A target date fund (Balanced Fund of Mutual Funds) designed to provide a mix asset of equity and debt to match the investor’s needs of growth and income with the help of SWP (Systematic Withdrawal Plan). CFP Level 2: Module 1 – Retirement Planning Page 34

Many investment companies (Offered by Mutual Funds outside India)offer target date funds . The concept is simple. Rather than the individual being concerned about determining an appropriate asset allocation, and then gradually shifting the percentages of stock and bonds, the fund does it all. The fund’s investment manager determines an initial asset allocation. The allocation then automatically adjusts as the investor ages. During the holding period, the fund remains diversified and professionally managed. Simplicity is perhaps the greatest benefit of target date funds. The investor only has two choices to make: the company to use, and the desired retirement date. Simple, however, does not always mean better, and target date funds present a few potential problems. Some of these funds come with higher than average fees which can include fees for the target date fund along with underlying mutual funds, and which can cut into investment returns. The solution is to work through a cost-benefit analysis and evaluate the results. A bigger potential problem is the glide path used to modify the asset allocation. This is a problem with two parts. First is the initial allocation between equities and fixed cash flow securities. The second concern is the tapering process used to shift the bias from equities to fixed cash flow. This problem is not limited to target date funds, and would be somewhat of a concern any time you use a standardized approach. There is simply no substitute for individualized solutions based on an individual’s specific situation and goals. Target Date Fund Glide Path (Blackrock, 2017) CFP Level 2: Module 1 – Retirement Planning Page 35

The allocation above begins with a heavy exposure to equities, moving over time to more fixed income and finally, to cash. Notice the different path when incorporating the same asset classes as in the above example; following a glide path leading to a 40% equities 60% fixed income allocation. Although there is debate about the efficacy of such funds, target date funds can be a useful tool. They do provide professional management and an asset mix intended to shift as the client approaches retirement. If an individual chooses to use a target date fund for part of a retirement portfolio, the key, in addition to the aforementioned cost-benefit analysis, would be finding a fund that uses both an initial asset allocation and glide path with which you agree. One big decision is determining the percentage of money allocated to equities, to support longevity, and fixed cash flow, to provide a more conservative cash flow-generating approach. It is possible that you can find a good mix and a good glide path, with reasonable fees. If so, and simplicity has value, a target date fund may be a good investment tool to keep in mind. People pass through various stages in their journey through life. Situations and goals change, and planning must change as well. As a rule, individuals do not fully know their own future, so planning for retirement should be a lifelong activity with regular review and evaluation. The process will endure throughout retirement, because conflicting goals and objectives continue and life never stops presenting obstacles and opportunities. We will look at lifestyle objectives next. Competing Client Goals Sometimes client has many commitments towards family and he is not in a position to start investing money for retirement goal, this goal needs to be postponed. It’s all well and good to encourage a client to put aside money for retirement, but when current inflows are barely enough to cover current CFP Level 2: Module 1 – Retirement Planning Page 36

outflows, retirement funding may be postponed. This is the dilemma many people face today. Current expenses continue to increase, either due to lifestyle choices or simply the impact of increased cost of living. At the same time, inflows are not increasing for many people, with the result that money available for retirement planning is not adequate. And there are costs of raising children and providing for their education, along with special events, such as weddings, and you can understand how a client might begin to wonder how he or she would ever be able to save for retirement. Some people won’t be able to invest for retirement. Unanticipated expenses, lifestyle choices, earned cash flow that does not increase, coupled with living expenses that do, can make investing for retirement an impossibility for some. When faced with this situation, there is little a financial advisor can do short of trying to help the individual maximize available benefits and get as much control of his or her budget as possible. Sometimes a person is able to earn more money by taking on another full- or part-time job. It may be possible to reduce expenses in other ways, such as driving a more economical car or living in a smaller house. Still, we have to acknowledge that, barring extraordinary circumstances, some people will not have the retirement of their dreams. This will not be the case for the majority of individuals. Most, given enough time, will be able to make the necessary adjustments to save and invest. However, this does not mean that these people will automatically be able to focus on retirement. As an example, parents may really want (or feel compelled) to help their children with the cost of higher education. Unless the children are able to obtain full government scholarship, university tuition and related expenses can be high, and finding the money to pay for them can be daunting. In this case parents need to be made aware of the education loan facility available for higher studies which can be paid by student after completion of studies. You can also help in paying the loan amount in case your financial situation warrants that. We know that the final years leading to retirement tend to have the highest earnings. If we build this fact into the plan from the beginning, and the individual follows through, he or she may be able to accumulate enough to make up for money used for other causes earlier in life. The process of determining retirement goals (in addition to what we have already discussed), and understanding the discrete components involved in meeting those goals, can be difficult for some people. It may be helpful to break down the components into the different areas a client’s wealth may be used. For example, one wealth-use objective is healthcare. This can be sub-divided or broken down into component parts of required medical care plus elective care, or perhaps, cosmetic care. CFP Level 2: Module 1 – Retirement Planning Page 37

The following diagram provides some guidance (Mac Gregor, 2006, p. 40). Fundamental Subordinate Objectives Objectives Home & Maintenance, Insurance, Transportation Basic Living Wealth-Use Healthcare Required Medical Care Objectives Elective/Cosmetic Leisure and Recreation Regular (annual?) travel Gifts and wills Special Travel Hobbies Philanthropy Bequests All the component boxes identifies a fundamental objective retirees may have. The first boxes then are subdivided into subordinate objectives identifying the components of the fundamental objectives. This process can help quantify retirement income requirements. During the evaluation process, the client should ask why each fundamental objective is important, and what comprises each subordinate objective. Remember, the client might have different views than the advisor on which items carry greater importance. After the client and financial planner have discussed and worked through the various objectives and their related implications, the client must fund the goals. At this point, we are no longer looking at pre- retirement funding. Instead, we will continue our thinking about funding options during retirement. The bucket system and its derivatives provide a good operating framework. Careful planning, suitably conservative investing, periodic evaluation and review and revision all play a part in supporting desired retirement withdrawals / distributions. CFP Level 2: Module 1 – Retirement Planning Page 38

Lifestyle Objectives Planning for retirement changes as a person progresses through life. Although a well-supported and meaningful retirement period may be a person’s late-in-life goal, during early stages, people keep postponing retirement because other goals like buying a house, car, accumulating money for education of children; their marriage and travel etc. take first place. In short, people at all life stages have to live, and the process almost always takes money and lots of it. Although we may have an distinctive understanding that the retirement saving process is best begun early in adulthood and continued throughout, there will be many competing priorities, with lots of places for available funds to go. Retirement planning during life’s different stages All the people go through life stages which are common for all  Accumulation phase (to about age 30)  First job/career  Paying off debt  Begin saving & investing  Marriage and children (for some)  Consolidation phase (generally age 30 to 60)  Home purchase  Marriage (for some)  Children  Children’s education  Peak earning years  More investable income  Retirement phase (generally age 60+)  Cash flow typically ends or is significantly reduced  Portfolios typically reallocated to a more conservative approach  Portfolio distributions  Wealth transfer CFP Level 2: Module 1 – Retirement Planning Page 39

 Long-term care issues With this as background, let us look at life stages from a deeper, slightly modified perspective. Beginning of career Wealth creation is a very important goal of life. It takes its own sweet time. The sooner you begin, the larger the corpus you can create. Unfortunately most people want to create a large corpus in a very short span of time or they begin investing too late. This turns out to be the disaster and must be avoided as much as possible. Having just started working, you start getting a steady inflow of money each month and you don’t have any real liabilities as you are either living with your family or friends. At this point of time, the burden of family responsibility is at a negligent level, making your income almost exclusively available to you. There is a strong urge to spend on the latest gadgets and other expensive items. Due to the host of options available, there is a lack of clarity about what kind of career you really want to settle upon. No thought is given to the concept of financial planning either because everything revolves around ‘today’ or due to the feeling of tomorrow being quite far away.For those who have familial responsibilities like parent’s health or a sibling’s education, it becomes difficult to start planning for self. Thus, keeping such goals in mind, every individual during this early phase should not just focus on the present but also work on saving and creating a solid base for the next phase of life. Here are some of the best ways in which this can be done: 1. Prepare a Savings Budget Typically, most of us budget our expenses; we first pay taxes, take care of mandatory expenses like EMI’s, rent etc. and then spend on lifestyle expenses. After bearing all these expenses, we save what little is left. Many a times, even those small savings are not channelled into productive investments. Burning one’s fingers in stock trading based on tips from friends and well-wishers or landing up with costly investment-oriented insurance policies are some of the most common mistakes people make at a young age. The best strategy to save is to have a saving and investment budget in place. This means that from the pay you take home, you must set aside a fixed amount that you save and then invest wisely. The balance can then be spent worry free. It is not about how much you are able to save; it is about starting to save and investing those savings in a disciplined manner. Even it means starting with 5% if your netincome and then gradually scaling up to 10-15%, most people can easily save 5-15% of their income without difficulty. Eventually, you should try to save and invest at least 25% of your income. This will ensure that over a period of time you will have a sizable corpus for your goals and your portfolio will be diversified by adding other asset classes. CFP Level 2: Module 1 – Retirement Planning Page 40

2. Set Goals Before starting planning where to invest, it is very important that you set goals. Setting goals will give you time horizon to invest and selection of which asset class to invest will become easy and appropriate. 3 Start saving early, invest for the long term An early start coupled with a regular and disciplined investment pattern has a significant role to play in creating retirement corpus. An early start ensures that you gain a head start over others and that you’ll retire with a larger corpus than someone who starts later in life. This is because the power of compounding works best over long tenures (5 to 30 years) and therefore rewards the investors who started early. Albert Einstein explains that compounding is the eighth wonder in the world, the enormity of which is not understood until it is experienced first-hand. For example, if you were to start investing at the age of 40 and invest Rs 10,000 per month (beginning of the month) at 12 %p.a. rate of return, you would receive Rs 91.98 lakh at returns by the age of 60 (over a period of 20 years). However, if you were to begin investing the same Rs 10,000 one year earlier, at the age of 39 years (over a period of 21 years) in an investment that yields 12% p.a., you would have Rs 1.04 crore by the age of 60. Simply by losing out on one year of investing would reduce your corpus by a whopping Rs 12 lakh (over ten times the money you invested in a single year i.e. Rs. 10,000 x 12 months =Rs. 1.20 lakh). If there was higher rate of return such as 15 per cent, the difference would be Rs 21 lakh (1.54 cr-1.33 cr).This is a clear indication that time does create money. We call it Time value of money. 4 Invest in Equity During an early phase of life, most goals are long term in nature. Hence, it is recommended to take very high exposure to equity. Most Indians think of equities or stocks (shares) as risky investments. This is exactly why their involvement and presence in the equity market is very low. Those who do invest in the equity market, do so on the bases of advice and tips from family, friends, television portals or stockbrokers. Equity being an asset class, should be a key component of every portfolio as it has the potential to provide the highest post-tax returns, especially in an emerging economy like India. But the proportion of equity in your portfolio can vary based on one’s overall objectives, returns needed for goals, time horizon, investments in other assets and the ability to stay well in volatile markets. CFP Level 2: Module 1 – Retirement Planning Page 41

Marriage and Family-building Getting married and starting a family is part of every one’s life, except very few. It is important for individuals to understand the potential expenses associated with marriage and beginning family life in addition to all the potential benefits. The moment child is born in the family; planning for his/her education is started by family. Children consume most available discretionary cash flow. There’s no way around spending money on food, clothing, medical care and all the other expenses that come with starting and building a family. There are also bigger expenses, such as saving money to fund college education. It may be that the focus on retirement savings will need to shift in this period to focus on college funding. However, if possible, clients should continue to save for retirement, along with saving for college. One reason may sound selfish. People know they will retire, but they don’t know that children will attend university. They cannot predict whether scholarships or grants may be available. They also don’t know whether grandparents or other family members may want to contribute to the college saving fund. Even if the children go to college, and no additional funding is available, parents can decide at that time whether they’re financially able to help pay tuition and other college expenses. Remember, too, the same TVM concepts that work for retirement apply to college funding. It is worth mentioning that having children immediately increase the client’s need for sufficient life insurance. Required amounts can be in lakhs. Term life insurance often makes the most sense, and premiums can be reasonable for the 20 years or so the insurance cover will be needed. Purchasing sufficient life insurance is a requirement of wise financial management and should be a top priority. Depending on the number of children, it is possible the family will need to look at purchasing a bigger home or building an addition on an existing house. Either way, this is another place for funds to go. Normally, during the period of developing a career, which often coincides with raising a family, incomes are likely to increase, too, so at least some additional discretionary funds should be available. Pre-retirement and retirement phase During this stage and the pre-retirement stage that follows, clients who want to contribute towards society/give-back in retirement may want to begin the process of giving now. Giving back does not necessarily mean using money. Many people understand giving means giving their time and sharing their expertise. Perhaps they can become mentors or advisors to younger people. Maybe they can support charitable causes and organizations that may be meaningful to them. Of course, they also may want to contribute financially. People who want to leave a legacy during retirement or after their death will also want to consider saving for that purpose. A client may like to start a school which provides free education to less privileged children whose affordability is low. Along with saving money, CFP Level 2: Module 1 – Retirement Planning Page 42

he can get government support and start an NGO. Planning for same needs to start early as it will also require big amount. Five to ten years prior to retiring, earnings are normally higher than at any other life stage. Major expenses are also taken care of. This is a good period for clients to increase savings to the fullest extent possible. This is not the time to spend to the fullest extent possible, although doing so may be a temptation. All the financial rules and guidelines from earlier life stages still apply. The money amounts will likely be different, but the concepts will be similar. This also will be a good time for clients to work through a thorough evaluation of retirement goals and preparations with you. The client will already have accumulated a sum of money by now which will need to be invested wisely. The client and financial advisor need to see if there is any gap to be filled. It is possible that investment strategies should be modified to help close the gaps. As an example, suppose the client wants to travel around the world in retirement. He or she may have little idea exactly how much money will be required to accomplish this. Let’s say the client has saved Rs.25,00,000 to fund this goal. Will it be enough or will more be needed? The advisor should begin by asking questions to learn details. How many trips per year? What locations? What class of fare (e.g., first class, business, economy)? Is this amount only for the couple or someone from family will also be travelling along? Assume a husband and wife plan to travel once each year during the first 15 years in retirement, then perhaps go on no additional trips. If the average airfare for two people flying business class is Rs.1,50,000, the advisor can determine how much will be needed and whether the amount already saved will be sufficient. In this hypothetical situation, one trip annually times 15 years is 15 trips total. If the average fare is Rs.1, 50,000, the total amount required will be around Rs.22,50,000. If we add other costs of around Rs.27,50,000, total amount to be accumulated is Rs.50,00,000. Assuming the couple has 10 more years in which to accumulate the necessary funds and can earn 12% on accumulated amounts, they will have to save an additional Rs.2,54,395 (rounded) at the beg of each year to have enough money. Keystrokes are:  Beg Mode  10 N  12 I  0 +/- PV  50,00,000 FV  P/Y=1, C/Y=1  Solve for PMT =-254395 (rounded off) Can they do it? That depends on their discretionary income, amounts required to fund other goals, and changes they are willing and able to make to their current lifestyle. If the amount will be difficult to fund, the advisor might suggest flying economy class. Each trip would then cost less.. If they invested CFP Level 2: Module 1 – Retirement Planning Page 43

the $50,000 already accumulated at 7% for 10 years, they would have a little more than $98,000 in their account. This means they could use some of the money for other purposes or switch between flying economy and business class for some of the flights. The point is, with a financial advisor’s help, they would be able to identify available funds and any gaps to make better planning decisions. It may also be that no changes are required. Either way, now is the time to carefully layout a financial strategy leading into retirement. Part of the process includes a revisit of life goals. The client will have lived 50 or 60 years by now. During that time, they will have developed dreams and goals that may not have existed at age 20 or 30. Children are probably grown, and the focus can more reasonably be on what a fulfilling retirement looks like to the individual. Now is the time to make necessary adjustments to help dreams become reality. During entire Retirement Over a period of time, spending patterns tend to normalize and will likely decrease. There is only so much travelling a person typically wants to do. There’s only so much home renovation; so much education. As they progress during retirement, many people begin looking at greater levels of philanthropic giving. This may involve a lot of money or a little, but many individuals want to leave some sort of legacy. Unfortunately, two factors can begin to negatively impact retirement funds. This first is inflation. Over time, goods and services cost more money. This results in an increased budget without additional expenditures. The amounts can be significant, too. At three and a-half per cent inflation, expenses double in around 20 years. If inflation jumps up to five per cent, it only takes a little more than 14 years for prices to double. Retirees on a fixed income often have to embrace a reduced standard of living. Those with greater assets will still feel the impact on discretionary spending, legacy gifts, and a decreasing financial safety net. Monitoring and reviews of retirement portfolio will help them maintain the required return. It may be good to schedule more in-depth financial reviews periodically. This can be a time to re-evaluate goal achievement, spending decisions and available retirement funds. It is possible that the retirees will have more money than they planned. It is also possible accounts will be smaller than anticipated. It’s often easier to make adjustments prior to an emergency than waiting until too much money is gone. Another unavoidable factor such as inflation is increased healthcare expense. No matter how healthy a lifestyle someone embraces, eventually, he or she will begin to wear down. If clients have planned adequately for these health care expenses, there will not be any difficulty managing this life change. Unfortunately, many people have not planned adequately, and when medical expenses increase, they CFP Level 2: Module 1 – Retirement Planning Page 44

run out of money. Few people voluntarily walk away from proper medical treatment, but doing so may become a requirement without sufficient healthcare cover and available savings. Depending on the health issues, surgery, hospitalization and recovery costs can run into lakhs of rupees. Even relatively smaller health issues can cost many thousands of rupees. This also is a good reason to build a financial cushion into the retirement budget Wealth Transfer Wealth Transfer is the transfer of wealth or assets to next generation /beneficiaries upon the death of the client through financial planning strategies that often include wills, estate planning, life insurance, or trusts in a tax efficient manner. Transfer of assets to next generation should be smooth and without any legal hassles to be faced by siblings in case proper will is not written. Estate planning is transfer of assets to beneficiaries in a smooth way. Clients with dependents will want to make arrangements to address the dependents’ on-going needs. This is especially true with minor children, but also pertains to spouses, parents, siblings, and adult children (and anyone else who may be a dependent). Special needs dependents often require extra preparation to ensure plans for their on-going care are in place. Broadly speaking, this aspect of estate planning can be categorized as people planning. The people-planning process helps to address dependents' financial needs as well as providing peace of mind. Clients will want to provide a guardian for their minor children and will want to ensure their aging parents have the financial resources necessary to provide for their needs. These goals can also extend to the client so that he or she has proper care in the event of incapacity. While finances certainly enter the picture, the primary focus of these goals is taking care of those who are important to the client, including him or her, and those for whom the client has a legal or moral responsibility. Clients also want to ensure their property is properly distributed. As is true when caring for children, this goal has a strong financial aspect. Following are a few ways this can be illustrated. Property inherently has financial value. Considerations might include ensuring the financial values are evenly distributed among children (or distributed in whatever way is consistent with client goals). The state also may demand payment of taxes related to the property distribution. The distribution itself may require payment of expenses to transfer the property. Also, the client normally wants to have some control over who gets his or her assets and under what circumstances. This includes the individual’s desire to support various philanthropic or charitable causes. Efficiency and effectiveness are also objectives. Clients want to ensure that assets will be distributed efficiently and without unnecessary legal or financial implications. Clients often want to ensure their assets are appropriately protected from creditors. Depending on the situation, a person’s assets may be frozen or seized in the event of legal action. The client’s lack of CFP Level 2: Module 1 – Retirement Planning Page 45

negligence may not do much to protect those assets from legal liability. Typically, individuals can take measures to lawfully protect assets through tools such as trusts, certain insurance contracts, offshore arrangements, and wills. Financial distribution goals include wanting to ensure assets retain as much value as possible while going through the estate distribution and management process. This could include keeping a business healthy and on-going. It might focus on providing maximum benefit for a surviving spouse or other family members. Keeping transfer and distribution costs as low as possible is almost always a goal. Where applicable, this would include minimizing relevant taxes. Personal Incapacity During old age many clients become incapacitated and need to plan for that possibility. As is true when thinking through the potential incapacity of others, clients may need the services of a guardian to take care of themselves, and a conservator or administrator to take care of their financial concerns. For obvious reasons, this is something best arranged prior to the time of need. Some jurisdictions allow for an individual to provide a power of attorney that authorizes someone to act on behalf of the individual. A power of attorney is a written document that provides the person receiving the authority (i.e., agent, or attorney-in-fact) with broad general authority or more specific limited authority. A general power of attorney typically ends when the principal (i.e., the person executing the authority) becomes incapacitated or dies. A durable power of attorney is often a better choice, because the agent’s authority endures throughout the principal’s period of incapacity. The agent’s authority may be immediate, or may only begin when the principal becomes incapacitated (i.e., a springing durable power of attorney). Given the potential authority of the agent, the principal should exercise care in deciding applicable limits and make professional referrals as needed. A client may also want to use a living will (where allowed). A living will or similar, typically is revocable, meaning the individual can change or terminate it. A living will’s primary purpose is to allow the individual to identify what kind of medical care — especially in the area of life-sustaining care — they want in the event of incapacity and inability to make those decisions. An individual may also choose to use other healthcare-related documents (e.g., medical proxy; durable power of attorney for healthcare). Regardless of the title, and whether or not a specific document can be used in a given situation, the idea is the same — to provide advanced directions so others know what the individual wants to have happen in the event of incapacity. Incapacity would also likely create the need for funding. This, too, should be addressed in the preparation process. Sometimes, insurance may provide a solution, but other times assets should be appropriately allocated. One possible solution for this is to create and fund a revocable living trust. The trust documents can provide for the individual’s care when needed. Since it is a trust, the documents CFP Level 2: Module 1 – Retirement Planning Page 46

can be fairly specific as to the way in which funding is provided and care is given. The person creating the trust (i.e., grantor) will need to fund it so money is available when needed. Since it’s revocable, the grantor could terminate the trust if necessary. Remember to always work with a qualified legal professional. Philanthropy Many people wish to give back to society and it is a positive goal. People for whom philanthropy or charitable giving is important often begin this practice early in life. However, in many cases, the individual may not have as much money as he or she would like to support the preferred level of giving. Often, as they work through the wealth transfer preparation process, clients may find they are able to do more than they previously were able. Philanthropic efforts can include gifts while the donor is living as well as bequests provided at their death. Depending on the jurisdiction, both gifts and bequests may provide some tax benefits to the donor, and these should not be ignored. However, for many people, any tax benefits are secondary to their desire to give back to their family or community in some way. Obviously, this is a personal decision, and there is no right or wrong answer as to whether, or how much, someone should give. Many clients want to share some of their financial well-being, and the financial advisor can help them do so. The client may simply give a gift to an organization or individual. Amounts can vary from very small to entire estates. The amount doesn’t matter as much as the act of giving. Of course, for some, the amount matters very much, because they want to do great things with their money, such as create scholarships or endowments; build hospitals or schools, and the like. While interacting with clients, financial advisors should ascertain clients’ philanthropic or charitable giving wishes. This is true throughout the client engagement, but becomes very important at the time of wealth transfer. One good way to learn how a client feels about giving is to ask. It is also simple that one or two questions on charitable-giving goals can be included in the initial discovery process. It is also a good idea to check in on this area throughout the client-advisor relationship. First on the wealth transfer list of goals is taking care of the client’s personal needs. It’s likely that retirement expenses, including medical expenses, will be higher than anticipated. A wealth transfer program that does not take this into account may run the risk that the client will run out of money. Many wealth transfer programs use strategies that involve removing the client’s ownership rights in an attempt to remove the assets and cash flow streams from the person’s taxable estate. While this may be a worthwhile endeavour, the financial advisor must exercise care to keep enough assets to meet on- going needs under the client’s control. In some jurisdictions, methods exist to effectively remove an asset from the client’s estate and also provide an on-going cash flow stream, and this may be a CFP Level 2: Module 1 – Retirement Planning Page 47

reasonable course of action. The point here is not to choose one good strategy. Rather, it is to remind you to keep the client’s entire financial picture in mind when exploring wealth transfer strategies. Let us take an example to understand retirement planning Question Your client Aruna wants to retire 25 years from now with the inflation-adjusted equivalent of Rs.45, 00,000 additional annual a incomes. Payments at the beginning of each year. As you and Aruna b discuss her retirement, you agree to plan for 30 years of inflation- c adjusted income in retirement. Annual inflation is stable at 2.9 per d cent, and Aruna’s portfolio is earning six per cent annualized. Aruna Correct Answer wants the entire amount in place at the beginning of her retirement. Explanation How much will she have to save at the end of this and every year for the next 25 years to meet her goal? Distractor #1 a Distractor #2 b 31,87,590 49,27,500 50,76,009 33,78,741 D Step 1: What is Rs.45,00,000 in today's rupees worth 25 years from now? Mode = END, P/Y = 1,C/Y=1 N = 25, I = 2.9, PV = -45,00,000, PMT = 0, CPT FV = 91,95,955.96. Step 2: To maintain purchasing power, the negative impact of inflation must be addressed. ((1.06/1.029) −1) ×100=3.01263. Step 3: Determine the amount needed to fund the next 30 years of Aruna’s inflation-adjusted retirement income payments. Mode = BGN, P/Y = 1, N = 30, C/Y=1 I = 3.01263, PMT = 91,95,955.96, FV = 0, CPT PV = -18,53,73,000. Step 4. Mode = END, P/Y = 1, N = 25, C/Y=1, I = 6, PV = 0, FV = 1,853,73000, CPT PMT = -33,78,741 Calculator in BGN mode for step 4 Calculator in BGN mode for step 4. I = 3.01263 for step 4. Need to use nominal rate - everything has been adjusted for inflation already. CFP Level 2: Module 1 – Retirement Planning Page 48

CFP Level 2: Module 1 – Retirement Planning Page 49