Why saving enough for retirement is difficult

Longevity risk, taxes, financial repression, unexpected high inflation, career risk, and psychological factors make it very difficult to save enough for retirement

If you don’t find the amount that you should ideally save each month for retirement shockingly high, then you have most likely made a mistake in calculating the amount that you will need (as I have written previously in this newspaper). Here are six reasons why it is so difficult to build an adequate retirement corpus.

Longevity risk

A 60-year-old upper-middle-class Indian woman is, on average, likely to live till the age of 83. So, if she plans for expenses till the age of 83, then there is a 50 per cent probability that she will live longer than that, and run out of money. There is no tax-efficient way to mitigate this risk in India.

Burden of tax and inflation

If inflation is 6 per cent and the return on the Nifty 50 index fund is 10 per cent, then capital gains tax at 10 per cent reduces the real (or net of inflation) return from 4 per cent to 3 per cent, an effective tax on real return of 25 per cent.

If the return on a fixed deposit is 6.1 per cent, then income tax at 30 per cent reduces the real return from 0.1 per cent to minus 1.7 per cent i.e. the effective tax on real return is 1,800 per cent.

Financial repression

Real returns on zero-risk debt mutual funds (overnight funds) have been consistently negative. The only way for the government’s debt to remain sustainable is for most individuals to bear this pain and subsidise the government.

Unexpected high inflation

Inflation is a hidden tax that is imposed by the government. It is also a tax that is extremely erratic. Even if the government would like to keep inflation at 6 per cent, it could shoot up to more than 8 per cent and stay at that level. So, the expected inflation might be 6 per cent and you might have put your money into a 10-year cumulative fixed deposit at a pre-tax interest rate of 6 per cent. However, if inflation shoots up to 8 per cent and stays at that level, the money you get back after 10 years would have lost 17 per cent of its purchasing power, even before you pay income tax on the interest.

Career risk

A 30-year-old software programmer may have assumed he will work till the age of 60. But it is possible there is no demand for his skill set by the time he is 50.

Psychological reasons

First, persistently high inflation in developing countries tricks the mind. Due to high inflation, for almost all of us, our net worth during retirement will increase initially, then it will gradually drop, and finally it will collapse rapidly towards zero.

Second, it is very likely that your peers have not done a detailed and accurate retirement calculation and are over-spending. If your calculations are accurate, your current lifestyle is likely to be much lower than that of your peers who earn a similar salary.

Third, many of our parents may have been entitled to a government pension or were dependent on their children during retirement. So, we are the first generation that has to learn to save half or more of our post-tax monthly salary.

Finally, we have to get buy-in from our family that it is better to look back and regret going on very few vacations, rather than regretting that we ran out of money during retirement.

The writer is an hourly-fee financial planner and a Sebi RIA at Fiduciaries.in. He was a private-equity investor for 12 years