One needs to understand how big the retirement corpus needs to be to lead a comfortable life in the golden years
Aman Jain, 27, is an MBA from a top-rated business school with a great job with a major retail chain. He has recently married his batchmate, Namita (also 27), who has a similar work-profile. Both live in a rented apartment in central Mumbai. Their parents have settled in their respective home towns and are well provided for. Both have good jobs which pay them Rs 35,000 each every month.
They have now started thinking about their retirement. They need to understand how big their retirement corpus needs to be so that they can lead a comfortable life in their golden years. They both expect to retire at the age of 58.
Let us understand a few concepts before determining their pre-retirement corpus requirement:
1. Life expectancy: With increasing medical progress, life expectancy is increasing. The average life expectancy in India is around 63 years. Urban and affluent classes typically have higher life expectancy as they have access to medication and expert consultations. Hence, conservatively, the Jains should plan for around 80 years of life. Also, note that the female life expectancy in India is higher than the male by about 2 years. Hence, when planning for retirement, ensure that the plan is made for both the spouses with relevant life expectancy.
2. Inflation: Money looses value as time: This phenomenon is called inflation. Assuming a 6% inflation, the Jains will require approximately Rs 3 lakh a month at the time of retirement (31 years from now) to enjoy the same lifestyle as Rs 50,000 per month would allow today. It is important to note that inflation will continue to erode the value of money even after retirement. Hence, the Jains need approximately Rs 11 lakh per month by the time they are eighty to live the same life-style as today!
3. Post retirement expenses: Post-retirement, the expenses are very different from pre-retirement expenses. This is primarily because office, commute and children-related expenses are substituted with medical costs. Similarly, one might decide to shift to their native town or a lower-cost city. Also, as the income falls, the tax incidence falls.
Typically, a person should budget for 70% of pre-retirement expenses as his or her expenditure after retirement. Hence, in the case of the Jains, who now spend Rs 50,000 a month, they should expect to spend Rs 35,000 per month in today’s value terms.
Having grasped these basic terms which impact your nest egg, let us try to compute the savings that the Jains need by the time they retire.
The practical stuff:
Step 1 – Determine the post-retirement annual income needed: Assuming, in today’s terms, Jains need Rs. 50,000 a month to live a comfortable life, applying the post-retirement expense factor of 70%, we estimate that the Jains will need Rs 35,000 a month in today’s terms to live a similar lifestyle after retirement. An expense of Rs 35,000 a month translates into a total expenditure of Rs 4,20,000 a year. Note that we have not yet accounted for the inflation, which we do in step 3.
Step 2 – Define the quantum of “bequeath”: You can, if you plan well in advance, determine bequeath that you want to leave your posterity with. Assume, the Jains want to leave a sum of Rs. 50 lakh in today’s value to their children, which will be available to them after their death. Note this also acts as a buffer against the surprise of life: either of the Jains living longer than 80!
Step 3 – Account for inflation: For every year (from the 59th to the 80th), determine the sum of money that will be required every year on a nominal basis (i.e. after factoring in inflation). We assume a 6% constant inflation rate. Hence, Rs 50 lakh bequeath in today’s value would mean a sum of approximately Rs 11.89 crore at the age of 80!
Step 4 – Determine the rate of return that your corpus can earn: After retirement, it is typically (well) advised that a substantial chunk of your money be parked in safe securities like government-guaranteed debt, bank fixed deposits, etc. While this protects your capital, this also means that you will get lower returns post-retirement. Given the current scenario, it is good to assume that you will earn 8% on your post-retirement portfolio.
Step 5 – Determine the present value of the annual amounts and bequeath: Calculating the present value means determining the principal amount that you need to have such that the interest and drawings from the same will meet your future expenditure needs. Assuming the 8% rate that we discussed in step 4, we determine the present value of each year’s expenditure and bequeath (as shown in column 3, of Table 1).
Step 6 – Determine the corpus required: Based on the present value calculated in Step 5, we can determine the corpus for the Jains. The amount that the Jains need to have before they retire at the age of 58, is approximately Rs 6.59 crore. The return on this corpus helps the Jains with two things a) to meet their yearly expenditure b) to build the bequeath for their children.
In the first year after their retirement, a return of 8% on the corpus of Rs 6.59 crore would yield Rs 52.7 lakh. Of this, around Rs 27 lakh would go towards meeting the annual expenditure and the remaining would go towards building the bequeath of Rs 11.89 crore (see Table 2) they plan to leave for their children.
Where can your financial planner help you?
To start out, we actively recommend that you do this exercise for yourself. If you approach the financial planner after that, the discussion will be more fruitful and can focus on the much larger issue of how to invest to build the corpus.
(The case is for illustrative purposes only)