retirement-planning


INTRODUCTION

Retirement planning is a complicated financial goal. When you save for a new car, exotic holiday or even for the education of your children, all or most of the accumulated corpus would get spent when the time for the goal arrives. It is easier to calculate the corpus required for such goals. When it comes to retirement planning, the corpus calculation is complicated because the corpus does not get spent in one go. It is supposed to be allowed to grow at some post-retirement interest rate and monthly withdrawals are made from it. For complete financial independence during retirement, these withdrawals or pension must increase according to the post-retirement inflation rate. Hence the retirement corpus calculation has to take into account not only the years to retirement, present inflation rate but also post-retirement inflation, number of years in retirement and post-retirement interest rate on the corpus.
 

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Retirement is the MOST important Financial Goal in India. Many of you may ask why? Hence consider the situations mentioned below.

1. Working life is Shrinking – We can see our working life is shrinking as we are students for longer time, we want to retire early and our life span is increasing. Our grandfather may have worked & earned almost 50% of his life which is now decreasing to around 30%. Lesser time we work, more we need to save to make sure we live a comfortable life after retirement.

2. Increasing Life Span – Life expectancy in India has increased currently. With increasing life expectancy, we need to have a corpus which can sustain for these longer retirement years.

3. Decreasing Savings Rate – Many people ask us why our parents easily created their retirement corpus but we are struggling and prime reason for that is decreasing savings rate. India is becoming consumption-driven economy, where we are spending more and more. In urban areas, even with much higher income than their earlier generations, they are saving much lesser.

4. Lack of Social Security – Old pension system for employees in Govt jobs (where employees used to get fixed pension all their life) is also replaced by NPS which is a contribution-based pension system (More you contribute, more you get – No Fixed Pension).

5. Cannot depend on Children – “My children will take care of me, when I retire” has emerged as the main reason for not planning for the retirement in India. With changing social and economic dynamics, our society is moving towards nuclear family units either due to cultural factors or due to economic factors. Studies have indicated that the joint family system has dropped from 35% to 31% in the last 5 years. Because of this, parents have to be financially independent, to sustain in their old age.

6. Decreasing Interest Rates – We are sure, many of our parents still vouch for products like Fixed Deposits, Kisan Vikas Patrika, LIC, etc. because they used to provide very good returns as the Interest Rates were very high in 1980's and 1990's. But things have changed drastically since then. Interest Rates on these products are not even matching the inflation and therefore our savings are not growing.

7. Lot of money required – Retirement goal is perhaps the costliest financial goal as you have to sustain with your retirement corpus for entire life after retirement. Here’s an example: If your current monthly expenses are Rs. 30,000; even a conservative 7% inflation rate will push up that monthly requirement to over Rs. 2 Lakhs in 30 years. To sustain those expenses for 25 years in retirement, you need a corpus of Rs. 6 crores at the time of retirement.

retirement-planning

 

How to calculate the Retirement Corpus?

Calculating Retirement Corpus will be the most complicated among all the goals. Since, mostly it is the goal which is furthest from today, there are maximum number of assumptions and you have to choose each of them, very carefully. Here are various factors which effect your Retirement Corpus –
 

1. Expected Monthly Income required after Retirement (At today’s cost)


First and foremost, is to decide on expected monthly expenses after retirement (at Today’s Cost). Assuming that your expenses will come down dramatically after retirement, is not correct. While some expenses may indeed go down, others like healthcare costs are likely to rise as you grow old, even though you may no longer be repaying loans or putting your children through school or college. Your travel expenses may also rise significantly as many are keen to travel after retirement. Therefore, you need to be prudent while calculating your post-retirement expenses. Financial planners say expenses after retirement are usually about 80 per cent of what one spends, during the work years.

2. Life Expectancy


Agreed that you cannot predict your life span, but an educated guess of how long your retirement period might be, is not a bad idea. Taking into account your present health conditions and your family's health history can help arrive at a figure. Lets take life expectancy as 85 years.

3. Price Rise


Inflation is a demon that keeps eating away your retirement corpus. So, taking the right inflation would be important to make sure you get to a right retirement corpus figure. India’s average inflation in last 20 years is around 6.3% and in last 5 years is around 4.9%. There was a period of high inflation from 2009 – 2013, where average inflation was more than 10%. So, clearly if we assume 10% inflation for the goal, then we are being very pessimistic and on the other side inflation of 4.9% will be grossly too optimistic. Ideally, we should take an inflation somewhere in between. Lets take inflation of 7% for this goal.

4. Current & Retirement Age


These figures will help you understand for how long you can invest for this goal. This duration will also help you in selecting the right Asset. If your current age is 35 years and you are planning to retire by 60 years, then you have 25 years to invest for the goal. Earlier you plan, more number of years you have for investment and therefore lesser will be your monthly investment.

5. Expected Rate of Returns


For Retirement Goal, you need to choose two Expected Rate of Returns – Before Retirement & After Retirement. These two figures are generally different as before Retirement, investor generally invest in aggressive assets like equity which give higher returns as the goal is wealth creation. But after retirement, investor becomes more conservative in his/ her investment approach as the goal is wealth preservation. So, you need to choose these two rates of returns separately, based on your risk profile. Expected Rate of Return will determine your monthly/ yearly investments, you need to do for this goal. Higher the expectation, lower will be the amount you need to invest. Expected Rate of Return is the figure which decides what type of asset you choose. More this rate of return, more risky assets you will have to choose to achieve the goal and vice versa.

Here, below given are some guidelines to choose the right Expected Rate of Returns (Post Tax)
Retirement Goal Duration      Expected Rate of Return, per annum
<3 Years                                              6%
3 – 7 Years                                           8 - 9%
>7 Years                                              10 - 12%
After Retirement                                   7% - 8%

The above given are the rates which should be considered as the expected rate of return on the post tax rate basis, considering you (the investor) is covered in the highest tax slab rate (30%).

Hence, consider at least 12% rate of (if you have more than 7 year for this goal) return for before the retirement returns, based on the investments made, considering you have invested in the equity oriented investments (for higher returns, as this is the time where you can bear the high risk associated with this investment). However, 8% for after retirement rate of return basis the investor has shifted the invests in more debt oriented investments (for low/ no risk profile), at such point of time.

Let us understand this through an example of Mr. Raju:

Where, Mr. Raju’s expected monthly expenditure after retirement (at today’s cost) = Rs. 50,000
Inflation: 7% p.a., Current Age of Mr. Raju: 35 Years, Retirement Age of Mr. Raju: 55 Years
Life Expectancy of Mr. Raju: 85 Years, Expected Rate of Returns before Retirement: 12% p.a.
Expected Rate of Returns after Retirement: 8% p.a.

Download Here my retirement calculator template.
Putting these values in any calculator, we get following values –

Case 1:

Retirement Corpus Required at age of 55 years: Rs. 6,12,96,304
Monthly Investment Required: Rs. 67,269 (For 20 years)
If Mr. Raju can increase investment by 10% every year, then monthly investment for current year will be – Rs. 31,809.

Case 2:

If Mr. Raju gets delayed by 5 years in planning his Retirement and actually start it when he is at the age of 40 years, keeping everything else same, following will be the change –
Monthly Investment Required – Rs. 92,698, for 15 years; Rs. 25,429 /month more.
If Mr. Raju can increase investment by 10% every year, then monthly investment for current year will be – Rs. 51,064; Rs. 19,255 /month more.

Hope you understand the impact of delay in investing for Retirement.

So, this example shows how Retirement is one of the biggest goal in life (size-wise) as well.

So to summarize the topic follow the following four simple steps to arrive at an ideal retirement plan.

Step 1: Decide how much income you require to live comfortably in your post-retirement years. Remember to take into account aspects like increased medical costs, expenses and gifts for family.

Step 2: Calculate the amount to be received in lump sum (terminal benefits) at the time of retirement.

Step 3: Select the right retirement plan that enables you to meet your post-retirement requirements. Preferably, choose to invest in asset classes, which can provide you with potentially higher returns in the long run.
Step 4: Start investing very early so that you have time on your side and can enjoy the power of compounding.

The question isn’t at what age I want to retire, it’s at what income. - George Foreman

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