Mutual Funds

How a typical middle-class family can juggle its finances

Meera Siva | Updated on January 24, 2018 Published on February 08, 2015

Our advice to the Nagarajans on how to plan for a comfortable retired life



This week, we take an in-depth look at the financial challenges faced by a middle-class couple — challenges that would strike a chord with you or me — to offer some solutions.

Read on for the details.

Two big goals

S Nagarajan, a former employee of Best & Crompton, runs his own electrical consultancy. Two things worry him right now — how to fund his daughter’s marriage and how to put away enough for his retirement. “My daughter just joined a job after completing her Masters, with a gold medal. We have purchased jewels, but do not have enough savings to manage the wedding expenses,” he says.

But his other concern is even more overwhelming. “I am 57 years old and think I may not be able to continue working after I turn 70. But I have no pension and no savings to speak of, and wonder if I can ever retire,” he says.

Income and expense

Nagarajan’s wife Geetha is employed with the Tamil Nadu Government, earning a monthly salary of ₹27,000, post-tax and deductions. She has five more years of employment and estimates that her pension will be around ₹15,000 per month when she retires.

Nagarajan’s income, of course, is unreliable. “Some months there is good cash flow but there are periods when there is no money.” Last year, he made over ₹10 lakh; but bringing in just ₹4 lakh in a year cannot be ruled out, he rues. He owns the house he lives in and it is fully paid for. Part of the house is let out and Nagarajan earns monthly rental income. The couple’s monthly expenses include interest payment towards a ₹4-lakh jewel loan and EMI of around ₹15,000 towards loans of ₹3 lakh availed by Geetha from her employer. Nagarajan has also enrolled in a 10-year LIC policy for which he has been paying ₹766 every month since 2013. The loan for their daughter’s education is nearly paid off now.

Assuming his income averages ₹25,000 a month, and based on his expenses (see table 1), the family’s monthly surplus is ₹19,500. All the members of the family are covered by a Mediclaim family floater policy for ₹5 lakh (with a cover of ₹2 lakh for Nagarajan and ₹1.5 lakh for the others).

The couple also has a total of four LIC policies which offer life cover of ₹5 lakh per person. One of Nagarajan’s policies for ₹1.25 lakh will mature in March 2015; their other policies will pay out in the next two years.

Priority for safety

The immediate financial decision the couple need to make is what to do with the funds received from the LIC policy that matures in March 2015. Nagarajan wants to invest it to start off his retirement savings. And what options are he considering? “Safety is the most important factor for me, even if the returns are low. I have no knowledge of shares and would not want to take risks. Some 15 years ago, I invested in private finance companies as suggested by my colleague. I lost nearly all the money and so would like to stick to tried and tested investments,” he explains.

Geetha also favours safe options rather than risk their savings to earn a few per cent more.

Given his low risk appetite, rather than investing in low-interest fixed deposits, paying off part of the high-interest jewel loans may be a better option.

This is because the jewel loan charges an interest rate of around 13 per cent, much higher than the after-tax interest rate of around 8 per cent they can earn from a fixed deposit. So, by paying down the loan, their monthly surplus increases to ₹22,500 from April 2015 (see table 2).

There are no other immediate financial needs besides their daughter’s wedding in the next two years. So in the two years they can pay off their outstanding loans and have a net saving of ₹1.5 lakh. For the marriage expense of ₹12 lakh now (around ₹13 lakh after two years), their savings and LIC proceeds of ₹3.75 lakh will not be sufficient. They would need loans from multiple sources — Geetha’s employer, loan against PF and jewel loans — to meet the wedding expense. Given that they can also take a loan against property, they can consider this as well. They can prioritise their loan sources based on cost of borrowing.

After the marriage, the couple will have a loan of nearly ₹8 lakh which must be paid off before saving for retirement can begin. (see table 3). Their monthly expenses will likely reduce by at least 10 per cent as their daughter is no longer part of their household. If there are no other expenses such as home renovation or medical expenses beyond the coverage amount, they will pay off the loan within two years (2019). It is also advisable that any surplus earned in the business is used to repay loans so as to reduce interest outgo. (See table 4).

By the time Geetha retires in 2020, the couple would have saved ₹7 lakh. This, along with provident fund and other retirement benefits of ₹12 lakh, would add up to ₹19 lakh. With Nagarajan still working and pension and rental income coming in, their retirement saving can continue, although with a reduced amount every month (see table 5). If Nagarajan also retires at this time, there will be a monthly shortfall of ₹8,500 (after accounting for the rent and pension). This can theoretically be met by investing their corpus at 5.5 per cent rate interest.

But given that one cannot predict interest rates and inflation, it is safe to work a few more years to build a corpus. One cushion Nagarajan has is that, in 2023, the LIC policy for which he is paying monthly instalments will pay out ₹1.5 lakh.

If Nagarajan chooses to work for 10 more years from now (2025), the corpus will be ₹49 lakh which can fund their expenses if invested at 3 per cent rate of return. If he sticks to his plan to work till he turns 70 (2028), their corpus would be at ₹72 lakh; this can fund expenses if invested at 2.5 per cent rate of return (see table 6).

While this sounds very comfortable, expenses would grow over time but not the corpus. So, this corpus will have to yield returns of nearly 5 per cent to meet their monthly expenses by the time Nagarajan is 80 years old.

Factoring in the risks

Of course, life can spring surprises over the long term (till 2028). Business income may increase.

But there may be unexpected expenses such as house repair or large purchases. And rent may not increase with inflation or the house may remain vacant, cutting into income.

Also, while we assume the corpus earns inflation-beating returns (inflation assumed to be 7 per cent and returns to be 8 per cent), it may not be the case. Inflation as experienced by their household spending may be higher than interest earned in a recurring deposit or fixed deposit.

The couple can consider AAA-rated NCDs to earn slightly more returns.

The couple have done no tax planning beyond LIC investments. They could consider investments that qualify for tax exemption. Likewise, better tax planning for business expenses can help them retain more of their income and fund retirement. The life insurance coverage is very low and needs to be increased. Both Nagarajan and Geetha are earning and plan to work for more years. So they need to increase their life cover. Geetha can take a 10-year policy with a cover of at least ₹10 lakh.

The couple should also increase their medical insurance coverage given that Nagarajan has had minor surgeries.

They can take up a super top-up policy in addition to the floater they already have. Premiums could be high and may cut into their savings, but it is worth getting a good coverage as medical costs are high and escalating .

Since their house is paid for, they have the safety net of reverse mortgaging the house or selling it if needed. While they are emotionally invested in the house, this option can open up choices to live well today.

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