Will your Pension be enough?

According to the 2011 census of India, 90 per cent of Indians do not have a  pension. Worse, even those among this 90 per cent who feel they have enough savings, many are lightly to run out of money sooner rather than later. The spectre of old age poverty looms over a grade number of India’s senior citizens, even among middle class once who think that their nest egg is enough.

The blame for this lies squarely on the combination of an entrenched but financial illiterate  culture of savings that has failed to move beyond fixed-income investments. Paradoxically, a drop in the inflation rate (and the fiscal good behavior of the government) is actually making thinks worse for senior citizens. Interest rates are dropping, dragging down the retirement incomes of those who rely on deposits. Compounding the disaster is the fact that for the actual expenses that older people need to make in their lives, the real inflation rate is worked as low as the official CPI.

The recent sharp reduction in the interest rates that the government pays on the various savings schemes it run has brought home the seriousness of this problem to many retirees. The logic of reduced rates is that interested rates and inflation in the economy are lower and small savings rates have been brought down to keep than in sync with them. Going forward small savings rates will be kept in line by re-aligning them quarterly with the general interest rates in the economy.

What’s worse is  that there’s an obfuscation in the way the reduction of rates has been announced and has been carried in the media. We were all  told that PPF (public provident fund) rates are down by 0.6 per cent. National savings certificate (NSC) by 0.4 per cent and so on. Technically, this is correct. yet, there’s a sleight of hand here because this hide the huge impact on the earning of depositors in these schemes. For example, the earnings on an SCSS deposit are actually down by 7.5 per cent.

Here’s the reality. An old person with the maximum allowed Rs. 15 lakh SCSS deposit was earlier earning Rs. 11,625 a month and will now earn Rs. 10,750 a month. That’s a big hit. Lower inflation and interest  rates, better fiscal management and higher economic growth are all very well but will carry no benefit for SCSS depositors because they are no linger in the earning and accumulative phase of their lives. Moreover, a lower official inflation rate is an illusory benefit for older people.

The real inflation in their lives is much higher than the official CPI rate. Healthcare and services are generally large and growing components of their expenditure. The prices of both these have risen much faster than the CPI. As society, we have no way for softening this blow. The only retirees who get the best of everything, along with inflation-adjusted pensions are government employees, who in any case are a special burden that ordinary Indians citizens must carry on their backs.

Going forward, it is quite likely that interest rates on the government deposit schemes as well as bank deposits will keep going down. That’s the reality that senior citizens have to face. Their income will go down, while prices will go up, even if at a reduced rate. Is there a solution that can mitigate that is problem ?

The answer to that is not one that fits easily in the normal attitude towards savings, specially post-retirement management of savings. It’s a cornerstone of the Indian savings mindset that old people must only put their money in deposits that are guaranteed by the government. However, these deposits barely earn anything after adjusting for inflation. As I’ve pointed out earlier, these deposits actually earn less than the real inflation that people face. Which means that not only does the deposit actually lose money, withdrawal and expenditure from these means eating into one’s capital .

I am sure financially knowledgeable readers can see where this discussion is heading. Old people need their retirement kitty to earn more, and there is really no way to suspend the fundamental rule of higher risk. What they need to do is to understand that focusing on the uncertainties of short-term fluctuations in the equity market while ignoring the certainty of inflation and poor fixed income returns in self destructive.

To put it bluntly, there is no way out except to take some exposure to equity in a measured, de-risked and  tax efficient way. The ideal method would be to follow these steps. First, keep roughly three years expenses aside and gradually invest the remaining amount into a set of two or three conservative hybrid funds (balanced funds). By gradually, I mean through a monthly systematic investment plan (SIP). After three years, you can start withdrawing every year from these balanced funds. An amount that is roughly three per cent of the total remaining sum. Roughly speaking this will give you an amount that is equal to what you are earning from a fixed income deposit today. And yet can the increased as prices rise but that’s not all. The best part is that the value of the remaining investment will also grow at roughly the inflation rate. If you can implement this, than there is a virtual certainty that you will not be faced with all age poverty. The icing on the cake is that unlike your deposit interest, this income will be tax free.

Financially and procedurally, this is an easy plan to implement an stick to. The problem is physiological and cultural. The average Indian has been conditioned not to do this, and is not able to handle the uncertainty. The value of the residual investment will fall and rise  everyday, month and year, sometimes more and sometime less. It will all even out to decent growth in the long term, you will need to be more sanguine than Indian savers generally are.

The lucky senior are the ones who have some sort of an inflation adjusted income , which is generally either a government pension or rent from property. For everyone else,  I see few alternatives excepted to learn that tolerance to a little bit of volatility  is a skill you have to learn for a long and prosperous old age.