Most people think that retirement planning is a complicated affair and use it as an excuse to avoid this critical exercise. However, retirement planning is not difficult.
“Retirement planning can be summarised as two aspects – save as much as you can and invest as well as you can. The earlier you start the more money you will save. Similarly, the better investments you do, your investment corpus will grow bigger,” says Rajan Krishnan, Director, Retyrsmart.com, a dedicated retirement planning platform.
If you are intimidated by the complexity of the calculations that go into planning a comfortable retirement, this week’s cover story will prove helpful. We have simplified the entire process into 10 steps that help you calculate your needs and compute how much you need to put away every month to reach that goal. This will also tell you whether you are ready to hang up your boots. We hope you find it useful in planning your retirement.
1. Split current monthly expenses into two
The first step is to calculate how much your expenses will be in retirement. Draw up a list of your total expenses. Most regular expenses such as grocery and utility bills, clothing, gifting and house maintenance will continue even after retirement.
However, several other expenses, such as travelling to work, professional clothing, home loan and children’s education expenses are likely to stop by the time you retire. So, consider only the regular items when computing your monthly expenses in retirement.
Experts say you should be pragmatic while calculating the total expenses. Your medical expenses may go up significantly during old age, which may nullify the savings from other expenses. “Instead of coming down, your expenses may actually go up during retirement years due to jump in medical expenses. So it’s better to take the current expenses only as the benchmark,” says Vikram Dalal, Managing Director, Synergee Capital Services.
“Ideally, expenses during retirement age should be equal to the current regular expenses,” says Anil Lobo, India Business Leader – Retirement, Mercer. Besides, many of the outgoing expenses get replaced by new ones, such as transport assistance and gifting. “We have noticed that the travel related expenses (travelling to religious places, relatives’ houses) also increase after retirement,” points out Rajan.
2. Calculate expected income after retirement
The next step is to calculate your total income from all sources. Whether it is pension from the company, pension under the EPS from EPFO, income from any insurance plan or pension policy, include all such incomes in the calculation. Similarly, include income from property that you expect to continue in your retirement. Since we have computed retirement expenses under Step 1 at current values, consider the pension based on current salaries only.
3. Calculate net income needed in retirement
Next, calculate the net requirement by deducting the value in Step 2 from the value in Step 1. For instance, if your expenses are Rs 60,000 a month and expected income is Rs 26,000, you need Rs 34,000 more.
4. Calculate the future value of the additional income needed during retirement
The additional income needed may appear small now. However, it will increase with time due to inflation. Though the current headline inflation is below 3%, experts advise investors to use the long-term average of 6% in their calculations.
“Instead of taking current low inflation, one needs to take long-term historical average for calculations like this,” says Lobo of Mercer. We have used 6% inflation, the average for the past 10 years, in our calculations. Even at this modest rate, a monthly expense of Rs 1 lakh per month will balloon to Rs 5.74 lakh in 30 years and to Rs 32.99 lakh in 60 years. The calculation in the table below is based on a monthly expense of Rs 1 lakh. Multiply the number with the actual value derived in Step 3. Multiply by 1.5 if it is Rs 1.5 lakh or by 0.5 if it is only Rs 50,000.
5. Calculate the retirement corpus needed at 60
Calculating the retirement corpus needed at 60 is a bit complicated, because it depends on the life expectancy, asset allocation and the returns expectations considered for different asset classes. “Since life expectancy is increasing on a regular basis now, everyone should plan for a longer retirement age,” says Balram Bhagat, CEO, UTI Retirement Solutions. “Ideally, one should plan till the age of 90 years,” says Krishnan. We have considered a life expectancy of 90 years in our calculations.
The standard practice of getting out of equities and moving to the safety of debt immediately after retirement is no longer applicable. This is because the retirement corpus now has to last nearly 25-30 years after the person stops working at 60. Therefore, one needs to maintain a significant exposure to growth assets such as equities even after retirement.
Many people might baulk at this suggestion but there is a logic behind it. “You will be using some portion of your retirement corpus after 10-15 years. There is no need to keep such long term investments in debt,” says Dalal of Synergee Capital Services. The higher equity allocation in retirement age is necessary, says Lobo of Mercer.
“People should gain from the power of compounding. Even a small increase in return due to increased equity exposure will be big in the long term,” he says. How much should be the equity allocation after retirement? Most experts suggest that the thumb rule of 100 minus your age should be followed even after retirement. This means one should have 40% exposure to equities at the age of 60 years and at least 30% allocation to equities at the age of 70. We have used the 100 minus your age rule for our computations.
The third element here is the return assumption for asset classes like equity and debt. Though most equity funds have generated low or negative returns during the last one year, we can’t take that as the benchmark. Instead, we should go with long-term average. “The Sensex has generated around 14% return in the long term. On a conservative basis, one can assume 12% returns from equities in the long term,” says Lobo.
Required retirement corpus at 60
Since the required retirement income will be more for younger investors, they need to save more
Similarly, the return from debt funds and bank FDs are also down to around 7% now, mostly because of the prevailing low inflation. But fixed income products have generated better returns in the past. Since their long-term average returns are around 8%, we have used that in our calculations. With inflation assumed at 6%, a 2% real return from debt is reasonable.
The graphic above shows how big a corpus is required to fund an individual’s retirement. If someone is 60 and needs an additional income of Rs 1 lakh per month, he will need a retirement corpus of Rs 2.57 crore to sustain till 90 years. Multiply your value from Step 4 to know your actual requirement. Don’t get upset if you see a very large figure here. The requirement will be higher for younger people because inflation will compound their expenses. “But young people have long time (20- 30 years) to create this corpus also,” says Sumit Shukla, CEO, HDFC Pension Funds.
6. Find out how much have you accumulated
Most people would have also accumulated some corpus dedicated for retirement through various instruments (EPF, PPF or NPS or other investment). Add all these up to know how much is your current corpus for retirement.
Saving for retirement
