Retirement planning for “free”: A case study of a case study involving 1.2 crores
Every week, The Hindu BusinessLine newspaper carries readers’ stories along with their financial data, their concerns and their enquiries regarding financial planning steps and their dreams about early retirement. Readers might recall that I had carried a one such story on the blog from the same newspaper on an earlier occasion.
Of some interest to me was today’s reader case study. Although not exactly about early retirement, the discussion that I had with DW on the case study as well as the points the study did not cover, opened more interesting questions and what-ifs, that we decided to share it with a wider audience. Here’s a brief breakup of the data of interest to us.
- 32 yo, son aged 2, take-home salary is Rs 55,000 a month (SISK – Single Income Single Kid). Salary expected to grow at 10% pa
- Home Loan monthly repayment is Rs 22,700 (loan amount: Rs 25,00,000 (25 lakhs), loan tenure 25 years)
- monthly household expense is ~Rs 18,100 (15000+3083 insurance premium) leaving a surplus of ~Rs. 14,000 for his investments
Objectives for this person:
- to pre-pay the principal portion of the home loan and to close the loan in 10 years
- to save for my child’s higher education, I may require Rs 40 lakhs
- for my retirement at 58 years (26 years hence) with a corpus of Rs 1.2 crore.
- planning to take a foreign tour in the next four years for which I need to save Rs 10 lakh
BusinessLine, please advise?
(Un)Known-(Un)Knowns: Choose your title 😉
- The man’s wife must be reeallly good at managing expenses. If I could contact them, I would definitely be asking them questions on how they manage with Rs. 15,000/month in Mumbai 😎
- Household expenses will shoot up for certain once his son starts (pre-)school. See here and here
- “Higher education” from an Indian context starts by college (UK: after A-levels), i.e., only by the time boy turns 16 years of age. The 40 lakhs isn’t needed until that point.
for a representative sample. In fact, I get such appalling numbers and stories about extortion development fund and daylight robberies fees these days, I am looking at homeschooling as a very serious option. With our own IIT/IISc National Programme on Technology Enhanced Learning (NPTEL), MIT OpenCourseWare and Khan academy it has become more and more possible and easier than most people think! And yes, it’s legal in India too!
I am going to tackle objective no. 4, chiefly because it is something I personally do not empathise with. My own sentiments on international travel concides with Jacob Fisker’s experiences, but compounded by my AVML/JVML requirements. So, if the man needs to have 10 lakhs for a foreign tour four years hence, he needs to invest all of that Rs. 14,000 surplus in equities, earning 12% pa (as per the journo), starting this month. This investment will return roughly Rs. 11.5 lakhs by the end of five years. I have deliberately omitted in this calculation, the additional contributions per month of approximately Rs. 1300, Rs. 2000 and Rs. 3200 that will be added to the surplus amount by years 2, 3, and 4 respectively due to the increase in pay. If those are factored the trip is a reality by the fourth year (It would seem the man isn’t stupid, for he seems to have worked these things out already and had a year in mind in his query).
What the journo doesn’t discuss in the paper is the “true cost” of the trip from a retirement/FI perspective, which is not Rs. 10,00,000, but Rs. 33,333,333 (that’s 3.3 !crores!). But true cost aside, this actually leads us to the classic discussion of “opportunity cost”, i.e., take the trip and you’ve totally foregone both your retirement corpus *and* your son’s education corpus for the next five years! Personally, keeping in mind the coming turmoil with onset of peak oil and job stagnation/outsourcing to other parts of the flattened world, I would say “to hell with the trip” and focus on the other priorities.
Retirement/Education Corpus Fund
According to the newspaper, Rs. 8000 invested for 15 years in equities yielding 12% pa would cover the 40 lakh education corpus and ~Rs 5600 invested for 26 years as above would cover the 1.2 crores for his retirement. Two factors not discussed by the paper, are additional insurance that the man needs to take (1.1 crores!) and how Rs. 8000 of the son’s corpus would give the retirement corpus a bigger boost from the 16th year onwards.
Pre-closing the home loan
The newspaper has treaded the hackneyed line (CYA?) in this regard.
“As long as the current tax benefits are extended for home loan interest repayment, it is better to avoid pre-payment of the loan”.
Personal Context: Yours truly is one of the many that was conned advised along the same lines and in a misguided moment of sheer adrenaline induced frustration madness, signed on the dotted line only to repent it in leisure since. After a long hard look at the facts and figures of this big concocted lie called “home ownership”, I have taken a somewhat contrarian position towards homeownership. I am not alone in this and here’s a few Indian articles questioning the rationale, empirically and with numbers.
So, back to the story, the fact that the man is being asked to base a long term, financially draining commitment on the whims of “tax-savings” and not based on numbers is a poor piece of advice, IMO. One main gripe I have with such advice is the outright refusal to consider increasing one’s monthly payments towards the loan to one’s advantage.
For the loan amount of Rs. 25 lakhs, based on his EMI amount, he is being charged 10% pa interest. So, by the end of 25 years he would have paid out Rs. 68,15,043 (68 lakhs) to the bank of which the interest is Rs. 43,15,043 (43 lakhs)!
Annually, the man pays out Rs. 2,72,400 towards his home loan (10% interest rate, revised every 3 months — only going to go up under current inflation trends!). Of this, he claims 1.5 lakhs as tax exemption under the tax code. Based on this, he would save Rs. 30,000 – Rs. 40,000 in taxes paid annually. By contrast, he pays out Rs. 1,22,400 in excess to the bank towards the mortgage which is his own money that can be neither reclaimed nor saved/invested.
Back to the big picture: He intended to pay back the loan by 10 years. So, let’s look at his loan outstandings and tax savings side by side for the entire loan period with his liabilities at 10 years from now.
|Amount paid out towards interest||Amount saved in tax during that period|
|10 years||23,40,136||40,000 x 10 = 4,00, 000|
|15 years||19,74,907||40,000 x 15 = 6,00, 000|
|Total interest||4315043 (43 lakhs)||10,00,000 (10 lakhs)|
There is no contest between the two. When compared to how much he is making the bank rich and what a paltry “tax savings” he is making, the man needs to pay off his home loan pronto and make better judicious use of his own money the way he feels fit.
To do this, he ought to increase his EMI payments by Rs. 12,000. By this he will close his home loan by 10 years(*). Classic opportunity cost scenario, for now he’s not able to save for his son’s education corpus fund! If on the other hand he sticks with the Rs. 8000 investment per month in equities towards son’s education corpus and moves Rs. 5000 into the EMI re-payments, the repayment window extends to 14½ years instead. He kills two birds in one stone. Son’s education as well as home loan: SORTED!
(*) Only if he had started paying 12,000 right at the beginning of the loan term. If he’s already into the loan by a few years, then it won’t be 10 years but somewhat different. I don’t know how far into the loan term he’s into now.
- If he keeps up a 12,000 payment for his housing loan as discussed earlier, the loan amount might be closed by 10 years. That leaves Rs. 2000 per monthtowards his son’s fund
- A 10% increase in salary every year is too optimistic IMO and his household expenses will be increasing as the members start ageing. So, I factored a 5% increase in salary and a 5% increase in expenses and re-worked the numbers.
- From the increase in salary, the man can increase his monthly contribution to his son’s fund by 2000, 4000, 6000, 8000 and 9000 by years 2, 3, 4, 5 and 6 respectively, and hold it steady from then on.
- He would have approximately, Rs. 2000, 4000, 7000, 10000, 13000 to invest into his pension from years 6, 7, 8, 9, 10 respectively. If he holds this payment steadily into equities, he will actually be able to reach his target of ~1.1 crores at the end of 58 years of age.
Since he has pre-paid the housing loan, from the 11th year onwards, he will have an additional surplus of nearly Rs. 50,000 per month (which excludes the payments mentioned above!). Even if his salary stagnates (a very likely possibility) and even if returns from the market is not exactly 12%, he will still be able to meet his financial commitments along with son’s education and retirement corpus. If he wishes to still undertake that ‘foreign trip’ of his, he could look at investing this Rs. 50,000 in equities for a period of 3 years at 12% pa, earning himself 20 lakhs and then take that trip. His son might also better remember the trip at this age.