Approaching retirement? You will typically have two objectives. One is to meet your (and your spouse’s) post-retirement lifestyle needs and, two, is to give a part of your wealth to your children after your lifetime.

In this article, we address the second objective — transferring some of your wealth to your children. Specifically, we discuss how you should enable the wealth transfer process, whether or not you have sufficient assets after providing for your post-retirement needs.

Be clear about your priority

Legacy portfolio is what you intentionally create at retirement or during the five years approaching retirement to transfer wealth to your children after your lifetime. This portfolio should be created with return-generating assets. You should necessarily keep this portfolio separate from your retirement income portfolio that you create to meet your post-retirement lifestyle needs.

You and your spouse should decide how much to contribute to the legacy portfolio. Remember, your first priority is your retirement needs, not the legacy portfolio. Why?

You have worked hard to enjoy a well-deserved retired life. So, it is only fair that you and your spouse first create your retirement income portfolio and use only the balance assets to set up the legacy portfolio.

That said, legacy portfolio should typically have large equity allocation. Why? The legacy portfolio has a long-time horizon, assuming you retire at 60 and have a long life expectancy. Of course, investing in equity could subject the portfolio to market risk. But you should be more concerned about asymmetric returns effect.

To understand asymmetric returns effect, consider this: It takes just 17 per cent decline in asset values to wipe out 20 per cent unrealised gains in your portfolio, whereas you require 25 per cent upside to recover 20 per cent unrealised losses.

So, even when the magnitude of gains and losses are the same, their effect on the portfolio can be different. This means you cannot afford to have too much unrealised gains or losses in your portfolio.

How can you moderate the asymmetric returns effect? First, fix the target portfolio value for the legacy portfolio based on the estimated time horizon. Given the amount you set aside at retirement and the target value, you can estimate the return that the legacy portfolio has to generate every year to achieve the target value.

Second, say the unrealised annual gain is 14 per cent and the required return is 10 per cent, sell assets to the tune of 4 percentage points of your legacy portfolio and invest in bank deposits. That is, you should sell assets to capture only returns in excess of your required annual return. During years when your legacy portfolio has unrealised losses, redeem these deposits and invest in equity.

Enjoying retirement

But what if you do not have enough money to contribute to the legacy portfolio? You should not reduce your post-retirement needs and use the money to create the legacy portfolio.

Instead, allocate the assets from your retirement portfolio to buy retirement income assets.

Then, create the legacy portfolio by buying term insurance policies with your children as the beneficiaries. The flipside is that term insurance policies do not have survival benefits.

So, if you survive past the policy cover period, your children will not receive any benefit. But that is the risk you should be willing to assume.

Setting up the legacy portfolio means that you can lead a comfortable retired life without having to worry about whether you will be able to transfer wealth to your children.

In extreme cases, legacy portfolio can act as a buffer to meet emergency requirements in your family.

The writer is the founder of Navera Consulting. Send your queries to portfolioideas@thehindu.co.in

Related Topics
comment COMMENT NOW