Retirement planning for self-employed: Invest in NPS, PPF and MF SIPs

Instead of reinvesting all surplus in business, invest a part in accumulating a corpus

Covid-19 has made people more aware of the need to save aggressively for retirement. Around 67 per cent of respondents in PGIM India Mutual Fund Retirement Readiness Survey 2023 said they have a retirement strategy in place, compared to 49 per cent in 2020.

The self-employed, however, were found lagging in their retirement planning and preparedness, said the survey that covered 3,009 people in nine metros and six non-metros). Of the respondents who said they do not need a financial plan, 40 per cent reside in Tier-I cities, have an income between Rs 50,000 and Rs 75,000, are aged between 51 and 60 years, and are mostly self-employed.

Different mindsets

The self-employed differ from salaried individuals in their attitude for retirement planning. “Salaried individuals tend to worry more about external events like economic slowdown, inflation, stability of job and income, etc. The self-employed tend to worry less about these aspects,” says Ajit Menon, chief executive officer of PGIM India Mutual Fund.

The survey found the self-employed tend to be impulsive in spending habits, likely affecting their retirement preparedness.

Diverse requirements

The self-employed have irregular incomes. “Their cash flows tend to fluctuate. This has an enormous impact on their ability to save. A salaried person has more control over cash flows,” says Jinal Mehta, a certified financial planner and founder of Beyond Learning Finance:

The self-employed also lack access to employer-sponsored retirement plans. “They do not have access to the mandatory Employee’s Provident Fund (EPF) and hence need to save for retirement on their own,” says Mrin Agarwal, founder and director, Finsafe India.

Underestimating lifespan, corpus

Many self-employed individuals follow a do-it-yourself (DIY) plan and end up making a hash of it. “They would be better off contacting a financial advisor,” says Mehta.

Some underestimate their life expectancy and the corpus required during retirement. Says retired Col. Sanjeev Govila, chief executive officer, Hum Fauji Initiatives: “The underestimation of how long their retirement savings need to last results in many outliving their corpus.”

Another mistake is not diversifying their retirement portfolio, according to Mukesh Kochar, national head of wealth, AUM Capital. “They often invest all their eggs in one basket,” he says.

Many begin to save for retirement very late. Says Mehta: “Many self-employed also do not have a fixed retirement age in mind and hence do not have a synchronised financial plan for retirement and estate distribution.”

Some don’t establish an emergency fund. When a financial crisis strikes, they use up their retirement corpus. Says Kochar: “The self-employed are also prone to taking loans and hence retire with debts. They then deplete their savings to repay their loans.”

What should you do?

Start early so that your savings get time to compound. Says Kochar: “Maintain a Chinese wall between business and personal income.”

Agarwal suggests drawing a fixed salary from the business and investing a part of it for retirement.

Self-employed professionals may be tempted to reinvest the majority of their savings into their business when they see better prospects. Says Menon: “They should diversify away from their business by investing in liquid assets like mutual funds.”

The self-employed should invest in the National Pension System (NPS), a government-backed, low-cost retirement avenue where they can choose the mix of debt and equity that is right for them. At maturity, a part of the corpus must be invested in annuities, so that they can receive a life-long pension. Public Provident Fund (PPF) should also be considered.

Systematic investment plans of mutual funds should be harnessed during the wealth accumulation stage. Says Govila: “The tax efficiency and flexibility of a Systematic Withdrawal Plan (SWP) remains unmatched in the withdrawal phase.”

Buy key person insurance – a policy that a company purchases on the life of an individual considered critical – to ensure business is not impacted by a mishap. For the self-employed, their business will take such an insurance policy. “Business persons should also consider Married Women’s Protection (MWP) Insurance to protect their families from creditors,” says Dilshad Billimoria, board member of the Association of Registered Investment Advisors.

                                            Options in PPF on completion of 15 years

I. Close account

Close the account, withdraw accumulated corpus tax-free

II. Extend by five years without contribution (Default option)

· If the investor does not express explicit consent to withdraw, or continue with contribution within one year of maturity, the account gets automatically extended without contribution

Once extended using this option, cannot ever go back to with-contribution mode

Corpus continues to earn interest

One withdrawal per financial year is allowed. Can withdraw even the full amount

III. Extend by five years with contribution

Need to specify within one year of maturity or the end of the five-year extension period by submitting Form H, otherwise default option applies

Requires fresh contribution each year; minimum annual contribution is Rs 500

One withdrawal per financial year. Withdrawal capped at 60% of the account balance at the start of the extension period