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Kuala Lumpur

Pension Planning

Home > Study Notes > Pension Planning
Published in: Finance: Banking
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This essay discusses the risk of different household have to face when they plan for their financial security during retirement. Firstly, I will introduce the potential risks of different investment products, then provide options to manage these risk and explain the different opportunities and constraints that needs to be considered.

Vinod K / Kuala Lumpur

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Qualification: Masters in Business Administration

Teaches: Business Studies, Finance: Corporate, Finance: Planning, Marketing: Strategy, Advanced Excel, C# (C Sharp), MS Office, Economics, Statistics, Business Mathematics, Management

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  1. This essay discusses the risk of different household have to face when they plan for their financial security during retirement. Firstly, I will introduce the potential risks of different investment products, then provide options to manage these risk and explain the different opportunities and constraints that needs to be considered. Introduction: Given the various economic changes and financial crisis faced by the world over the past years, retirement savings has been one of the major concerns for people during the working age. As can be seen in the figure 1.1 below, saving over the life-course tends to increase until the age of 45, and then starts to decline sharply, resulting in little or no savings beyond retirement. Therefore saving for old age is one of the four main motivations for an individual or a household to plan their investments and savings. 45 000 40 000 35 000 30 000 25 000 20 000 15000 10 000 5 000 -s 000 -10 20 Net income 25 30 35 Expenditure Net saving 40 45 Age 50 60 65 70 75 Figure 1.1 Saving over the life- course
  2. Risks associated with financial security in retirement: Financial planning for retirement is not without its risks and challenges. There are three main risks that one should consider to mitigate when planning for retirement savings, namely, uncertainty of future investment returns, incorrect estimation of inflation and unpredictability of lifespan or longevity. The risk of investment return is that, one cannot guarantee the return of financial products. While government bonds, funds and ISA are often seen as secure financial products with less return, equity stocks, futures and options that provide for high returns carry significantly larger risks. Inflation, on the other hand, reduces the buying power of money over period of time. For example, if you buy financial products assuming that interest rate is 5 percent and maximum inflation rate is 3 percent after 10 years you will experience a real increase of only 2 percent due to inflation. Hence saving for retirement could be significantly impacted if during the working life one assumes an inflation rate that is lower than the actual inflation rate at the time of retirement. This may result in lower availability of funds than the actual expenses that would incur post retirement. Lastly, while planning for retirement one must assume a certain lifespan during the working life to be able to support post retirement. Longevity, in this regard, poses two challenges, firstly, your fund or saving may not be enough if you live beyond your assumed life span or the funds or savings maybe more than what is needed if you do not live up to your assumed life span. In the second case, there is loss of investment opportunity during the working life that could have been used for other purposes such as education, housing or healthcare needs. Mitigating the risks: While it is not possible to entirely avoid such risks there are ways to mitigate these risks. Firstly, one could diversify the investment portfolio to have a considerable spread of risks with various possible investment and savings instruments such as unit trusts, life insurance funds, investment trusts, Open-ended investment companies, Exchange-traded funds, corporate bonds, and last but not the least are equity shares. Secondly, gather data on the country's inflation rate and data on inflation rates of other similar countries for the last 20 years. Additionally, collect forecast data from various sources such as World Bank and IMF to make an informed guesstimate of the maximum inflation rate to guard against. Finally, collect information regarding the average lifespan of ones gender, nationality, and ethnicity.
  3. Correlate the data with the lifespan of your family members and estimate longevity based accordingly. Retirement planning opportunities and constraints: There are various ways to plan the finance for retirement. Pensions are the most common schemes. However, there are various pension schemes such as Occupational defined benefit scheme, Occupational defined contribution scheme, Personal pension and State pension schemes. Pensions are not the only financial instrument for retirement. There are other instruments, as mentioned earlier, that can also be considered. Investing in property to gain a significant rental income during retirement is also an established method. Finally, a healthy lifestyle could enable an individual to work beyond the state-pension age or retirement age. Each opportunity is different and one must assess their individual and household situation before planning the suitable schemes. There are many competing demands for household expenditure and financial planning. For instance, a couple could plan for their child's education, this means there will be lesser funds available for alternative investments. During the early 20s of the working life, an individual may not prioritise for retirement and may be motivated to take risks with various alternative financial instruments. However, as the individual approaches 30s the appetite for risk reduces and other priorities such as buying first home and raising a family becomes important. One needs to understand that each household and each individual have different perspectives of the same need. Differing household priorities and needs leads to a large inequality over period of time with respect to retirement savings. For instance, a couple in early 30s with 1 child may aspire for a home of 2,500 square feet in size. While, another couple also in early 30s with 1 child may only aspire for a home of 1,000 square feet. This dictates the amount spent on homes, consequently, it determines the mortgage amount required to support such a home. While personal preferences can be adjusted, one also needs to be prepared for unforeseen circumstances that can create a dent in the financial security plan.
  4. Conclusion: All these variables determine the extent of investment an individual could plan for retirement during the working life. Given all these aspects, an individual needs to do 3 key things while planning for retirement. Firstly, assess the situation of their potential retirement period and estimate the amount of income that is required to support post-retirement life. Secondly, develop a financial plan to gain the required income during the post-retirement life. Thirdly, act on the financial plan and review the plan on an annual basis to ensure that the finances are performing adequately to support the post-retirement life.

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