The Retirement Game (PART 1)


This is a rewrite of the article which I wrote in June 2007 for Smart Investor with a 2020 update.


The unthinkable will happen: one day you will reach retirement age! What are you doing to prepare for it?


The journey to retirement is a one-way ticket. The big questions is, how much is enough? For many of us, that's the RM1 million question. Or is it RM2 million? Or maybe it's RM899,999 or something far smaller? Just how much do you need for a happy, healthy and, with any luck, long retirement? Pinpointing the right numbers can be as frustrating as herding cats.


This is one of the biggest financial challenges you will ever confront. If your calculations are wildly off base, retirement won't wait for you to catch up. Once the pay-cheques stop, your options disappear.


For those already retired or nearing that milestone, the question is even more complicated: how much dare they withdraw from their savings? Will the mixture of stocks, bonds, properties and cash accumulated over a lifetime hold together like cement? Or will it unravel slowly like loose yarn on a cardigan sweater?


Regardless of where you are on the retirement timeline, you will inevitably ask yourself: Am I investing wisely enough to get to where I want to go? Smart investing, however, is only part of the equation. The age at which you begin saving is also important. So too are the retirement benefit like EPF that you may be entitled to at work.


Your family tree could also influence your savings strategy. Did your grandparents or parents live long enough to celebrate the birth of great-grandchildren? If they did, you could be among the increasing numbers of Malaysians who will spend one-third of their lives in retirement.


If you did not start saving early (most people don't) and you are not a particularly astute investor, you do not have to be fatalistic. Here's some good news: the people who live comfortably in retirement are not always the ones with the biggest pay-cheques during their working careers. Plenty of six-figure salaried people divert a bulk of their earnings toward propping up opulent lifestyles. Other affluent Malaysians jeopardise their retirement years by favouring a macho investing style more akin to John Wayne than Warren Buffett (including investing in schemes that scam people). The wants and needs of a person define the level of comfort at retirement. They give us a definitive answer to how much is enough and how you should invest your money.


ACCUMULATION STAGE

The accumulation stage is pretty crucial in our journey towards retirement. Mistakes made in investing and putting less money into your retirement account would warrant a delay in your retirement or a drop in your lifestyle. Before you start, you may want to protect yourself against economic and personal risks.


It would be a good idea to set aside three to six months of your income into fixed deposits or Amanah Saham Bumiputra (for bumiputras). This emergency fund would resolve any economic risk of losing your job or a business slowdown.


Have you ever been trapped in your own living room by an insurance agent who shows no sign of getting off your couch? With him testing the limits of your hospitality, you may be willing to do anything to get him to leave and reclaim your couch, perhaps even something drastic like buying a policy.


If you had such an experience, you would appreciate what people in the industry readily admit: insurance policies are sold, not bought. Few people wake up one morning and decide to search for a cash value life insurance policy or health insurance policy. Even fewer souls start the day searching for a disability or long-term care insurance policy. So, unless a next-door neighbour, your brother-in-law or a friend-of-a-friend cajoles you into buying a policy, it might never happen.


The decision to obtain insurance coverage should not depend on whether any of your siblings marries an insurance agent. Yet, people still get pushed into purchasing coverage all the time, without evaluating what they truly need.


Although it s not the most exciting prospect, most people need to seriously consider their insurance needs and shop for the necessary policies instead of buying something just to get someone out of their living room.


PROTECT YOUR INCOME

If we do not properly evaluate and buy the cover we need, we may face all sorts of problems in later years when the consequences of such haphazard decisions return to haunt us or our loved ones. When you buy life insurance, you are really buying protection for the necessary income your livelihood produces.


Countless policies exist today, which contributes to the loathing people have for life insurance shopping. Actually all these options can be broken down into three broad categories: term, cash value (also called 'whole life') and hybrid insurance, such as investment-linked insurance.


Term insurance is intended to replace your income for any dependents you leave behind. It is sold in chunks of time, such as 10, 15 or 20 years. Many people opt to have their term insurance expire when their youngest child graduates from university or college.


People usually buy this type of coverage if their untimely demise could cause tremendous financial hardship for the family. Parents with child still living at home are heavy users of this insurance. Childless couples would also find this insurance valuable if only one person worked outside the home.


Term insurance is rarely appropriate for retirees because the premiums payable at older ages are exorbitant. Then again, the elderly do not need life insurance. Once they leave the workforce, there are no pay-cheques to insure unless they want to leave a legacy to their next generation.


BEST CHOICE

In an overwhelming number of cases, term insurance is the best choice. People who choose whole life insurance run the risk of buying an expensive policy they do not need. What is tricky about these policies is that you may not even know if you have been ripped-off!


Although insurance agents talk up the investment features of whole life insurance, most people would be better off buying term life and investing the premium difference into solid, low-cost unit trusts or other investments.


Nonetheless, due to the high cost of term insurance for older Malaysians (many companies do not even offer it to people past 70 years of age), the affluent elderly often use whole life insurance. They want insurance to pay for potential expenses after their deaths.


Investment-linked insurance is effectively a term insurance bundled with a unit trust. It is slightly better than term insurance but the 'cash value' depends on the investment returns of the unit trust. They could be as cheap as term insurance for young people, but again are not viable for older folks. There are potentially cash back when you do not need protection anymore unlike term insurance, which does not have this feature.


The 2020 version: However, in Malaysia, the caption buy term and invest the rest may not be very sensible because of the way term insurance is priced. The savings from the premium paid between term insurance and a cash value insurance, if invested does not really translate to meaningful endeavour in both total protection and total cash value as compared to buying a cash value insurance. We are still better off in terms of piece of mind and the benefits we received from the cash value insurance.


As for the term insurance with premium refund, one would still be better off putting ones money into an investment-linked as the premium paid can potentially be cheaper with the feature of full premium refund at the end of the policy term, just like the term with refund. And in terms of returns from the investment-linked funds, most insurance companies do have the capacity to compete with their unit trust counter-parts if not better.


A discovery in my 13-years journey from the last time this article was published. The term insurance in Malaysia are priced not as cheap as our counter-parts in Singapore, Australia, UK and US. The caption buy term and invest the rest does not really work in Malaysia.


Thus, the best choice of insurance product purchasing today all boils down to the needs, keeping the cost of insurance between 10% - 15% of one's income and finally to keep the long term in view, don't buy insurance just to plug the leakages to our wealth but also to ensure that it can also enhance our wealth in the process.


HOW MUCH TO INSURE

There are a few methods to estimate how much life insurance you need. One of them is to get a policy that represents 10 times your annual income. The insurance proceeds, when invested to return between 6% - 8% a year would generate 60% - 80% of your actual income.


Another method is to determine how much is necessary to generate an income stream that can adequately support the surviving family. This method can be cumbersome as one may miss out the necessary expenses as one have to estimate what one's family needs would be after a death, including long-term expenses. These may include funeral expenses, settling a mortgage, the usual household costs, unpaid medical bills and future university or college tuition fees.


Do not forget to factor in inflation and taxes. Also, do remember to purchase life insurance for the stay-at-home parents who takes care of young children. In the event of that person's death, childcare could become a huge expenses one can expect.


Single people are usually not life insurance buyers, but there are cases when it is a practical move. If you bought a house with a live-in partner, your share of the mortgage could be paid off with life insurance. Purchasing life insurance may also be a wise move if your parents are dependent on you financially, or if you want to leave money to a friend, relative or charity.


One should also pick up health insurance, of course with the consideration of whether your working place has adequate coverage for its employees.


Once you have covered your economic and personal risks adequately, you can then plan your retirement with better piece of mind!

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