Financial planning for young professionals: Making the best of earnings

Updated: Sep 23 2013, 20:22pm hrs
InvestmentsYoung professionals need to make a small contribution towards retirement planning to have a sizeable amount by the time they reach the age of 50.
On an average approximately 4 to 5 million new professionals below 25 years of age join the workforce in India every year. This workforce needs to draw up the right financial strategy right from the beginning in order to make the best of their earnings while not compromising on the lifestyle that they desire and deserve.

Rahul, 25, is a young IT professional who earns about Rs. 3 Lakhs a year, is single and lives with his parents. His father is currently in employment.

Life is pretty cozy for Rahul as he does not have any family commitments and earns a decent amount of money to enjoy a relaxed and fun lifestyle. However, it is important for him to give a serious thought to planning out his finances for the future. Here are some of the aspects that he must cater for during these carefree days of bachelorhood.

Start Saving Early

With all the primary household expenses taken care by this father, Rahul could easily save up to 25% of his earnings right from the beginning. This will enable him to tap the power of compounding with this savings in the long term.

Long Term Investments

He can choose debt investment instruments that offer tax rebate as part of a long term investment plan. He could also explore options like ELSS and also opt for SIP in order to even out market fluctuations in the long run. This works best for young professionals who do not have many financial commitments.

Health Insurance

Though youth is synonymous with health and fitness some ailments and conditions come unannounced for which Rahul will have to plan. For his needs, taking a health insurance cover of Rs. 100000 with a premium of Rs. 10000 annually will be adequate and also provide tax benefits under Section 80D.

Credit cards/ Debts

Rahul will need to use credit cards judiciously, make regular full payments and avoid high interest rates.

Emergency Funds

This is a must in case of sudden emergencies like a job loss, a family emergency or other critical situations.

Rahul is now 30 earning an income of Rs 6 lakhs a year. He is now married and his father has retired.

Marriage heralds the beginning of financial responsibility as one starts a family. Additionally in the case of Rahul his father is living on his pension. He would now need to become more responsible and also be in a position to extend any financial support needed for his father.

Life insurance

Now there are two aspects of security that Rahul must cater for His wife and his parents. Thus he will have to work out the exact amount of life cover that he needs and then take policies accordingly. Typically a cover of Rs. 30 L, for a premium paying tenure of 20 years will have a monthly premium of Rs 11000/- on average which is adequate in this circumstance.

Health Insurance

Health insurance for husband as well as wife must be opted for right after marriage. Rahul can take any such joint plan with a cover of about Rs. 3L, which will require an annual premium of about Rs. 4000 providing facilities such as cashless treatment, pre and post hospitalization expenses and cost of treatment of listed conditions.

Investment planning

This is the right time for Rahul to start investment planning by opting for any of the market options available after a thorough study and consultation with his professional financial advisor. Some of the common options available are shares, mutual funds, ULIPs and more secure instruments like fixed deposits in banks. However since Rahul has age on his side he should opt for slightly aggressive products that could give him better returns.

Financial Goals

This is the right time for Rahul to take stock of the situation and chart out his financial goals in terms of assets that he desires to accumulate over the next two decades. These goals will henceforth dictate his savings and insurance plans.

Retirement Planning

Rahul will need to have to look at the retirement planning tools available in the market and commence making a small contribution towards this aspect to have a sizeable amount by the time he reaches the age of 50.

Rahul, 35, is now the proud father of a 2 year old daughter and has an annual income of Rs. 8 L. He has accumulated about Rs 7 Lakhs in savings and has Rs 2 Lakhs in his PF account.

Rahul has now 2 dependants and this is the time for him to start looking to buy a house for himself. Additionally he must plan for his daughters future along with consolidating his retirement plans.

Life Insurance

At this stage the need for cover for Rahul will be around Rs. 50 Lakhs so that his wife and daughter can maintain the same lifestyle in any unfortunate case of his sudden demise. A term insurance for this amount will require an annual premium of Rs. 15000/-

Health Insurance

A comprehensive family insurance of Rs. 500000 will require an annual premium of Rs. 5000 approximately providing all the requisite facilities.

Purchase of House

This is the perfect time for Rahul to buy a house. With an annual income of Rs. 8 lakhs he can easily get a home loan of 5 x 7 (annual Income) = Rs 35 Lakhs. However Rahul should go for a house of about Rs. 25 Lakhs for which his contribution will be about Rs. 5 Lakhs as down payment that can be drawn from the savings he has made so far. The remaining Rs. 20 Lakhs can be taken as a home loan with an EMI of about Rs. 21000.

Daughters Future

Planning for the daughters future should be on the top of the agenda for Rahul now. This includes cost of higher education which is about 16 years away now and will require about Rs. 15 Lakhs as an approximate expense for any private college. Thus Rahul must start saving accordingly from this time onwards on a regular basis. Marriage of the daughter is a situation far ahead and the actual cost can vary drastically but it does require some disciplined savings from now onwards.

Retirement Planning

Rahul has Rs 2 Lakhs in PF for which he maybe contributing Rs. 20000 annually and it will grow to about Rs. 28 lakhs in the next 25 years at an 8% growth rate. However for life till about 80 years he shall need Rs 1.3 Cr. to keep up his lifestyle even after retirement. Thus he will have to increase his contribution towards this aspect through other retirement tools to about Rs. 80,000 per year.

Investment Planning for Rahul: By the age of 35 Rahul should have started dedicated investments to create a corpus required in later stages of life. He should expect returns at an average of at least 8 -12% on his investments. Therefore all his monthly savings of around Rs 8000 can be invested through SIPs. Additionally he can consider moving about Rs. 2 L from his low return (3.5%) bank savings account to a more liquid option that provides around 6% annually. The balance Rs. 1L left in the savings account must be invested as a lump sum in some debt/equity fund which shall earn a better annual return.

Tax planning: Rahuls total tax liability is about Rs. 170000 annually. He must make sure to avail the advantage of Section 80c tax benefits of up to Rs. 1L. This will save about Rs. 30,000 in taxes. Since he is already contributing Rs. 20000 toward the PF account which he will increase to some extent the rest of the amount can be invested through SIPs in instruments that are exempt under 80C such as ELSS.

With such a plan in place Rahul can hope to have decent savings for his retirement after having ensured the best quality of education for his daughter and marrying her off happily. The savings and other investments made by Rahul from the beginning will help him live a comfortable lifestyle in his own home along with his wife several years after his retirement without having to depend on anyone else.