Retirement planning – How much is enough?
“You can be young without money, but you can’t be old without it.” – Tennessee Williams.
Recently, I had a conversation on Twitter about retirement planning. Personally, by retirement, I don’t mean not doing anything or not earnings anything. What I mean is not being in a regular job that doesn’t excite you. The reality is that many of us are in jobs for purely financial reasons. By retirement, I mean having the flexibility to do something that we really want to do. It simply means having the flexibility to choose what to do without worrying about its financial impact.
My father retired a few years ago after 38 years in a government job. He likes to read and write and he had lots of time. But somehow, he was not feeling great with all the time at his disposal. After some time, he started doing a few things that always made him happy. I saw him happier and also more physically fit.
Things to consider before thinking about retiring
You can find some information regarding the mental preparation for retirement here. In my view, few things that need to be checked or done before even thinking about retirement are:
- Be debt free.
- Have a home for your own usage.
- Have health insurance for yourself and your spouse.
The main question that worries every one thinking about retirement is how much is enough and how long the corpus will last? We try to address these queries on retirement planning below.
An idea on how much you will spend when you retire
It will be good to have an idea about what will be our monthly expenses when we retire. Although, as we grow old, the items we spend money on change, our present expenses give a good picture of what our expenses could be when we retire. The below table gives an idea about how your expenses will grow for different level of information:
- If you are 10 years away from retirement, your monthly expenses upon retiring could be 1.8x your current expenses (assuming 6% inflation).
- If you are 20 years away from retirement, your monthly expenses upon retiring could be 3.2x your current expenses.
A word on adequate retirement corpus
The simplest assumption could be that your investments will fetch you the same return as the inflation and then you need to do a very simple calculation to know about what is a good corpus size for achieving financial freedom:
How long will it take to accumulate such a retirement corpus?
We need to make some simple assumptions on:
- Saving rate: Normally, people look at saving as a percentage of their income. That is a bit misleading. What is important is what proportion of your current expenses are you saving for your retirement. In our calculations, to get a better idea, we use how much you save as a percentage of your monthly expenses. So, if your income is Rs 100, your monthly expenses are Rs 50 and you save Rs 20, then it means you save 40% of your monthly expenses.
- Inflation: In our calculations, we assume an inflation of 6% in savings as well as expenses. It means that our expenses are increasing at 6% but we are also increasing our saving amount by 6% every year.
- Rate of return on investment: Once you save money and invest, your money grows. On a portfolio basis, we use a return of 12%. For generating this type of return, one will need around 60% to 70% allocation to equity.
If you save an amount equal to 20% of your expenses, after 30 years, your retirement corpus will be 23.4x your annual expenses at that time.
How long will your retirement corpus last?
How long will your retirement corpus last depend primarily on two factors
- Investment return on retirement corpus: Higher the return, longer the corpus will last. Instead of absolute value of return, what is more important is the real return on your portfolio. Our analysis suggests that a 20x corpus earnings 6% real return will see you through your retirement life. However, if the real return is 0, the portfolio will last just around 20 years.
- Size of corpus: Quite clearly, bigger the size of corpus, longer it will last. In our analysis, we have used just regular expenses for you that increase at the rate of 6%. If you have additional expenses (kid’s marriage, world travel), you need to provide for them as well.
Finally, to summarise:
- Retirement shouldn’t mean an inactive life. It should also not mean no income at all. Ideally, it should lead to you doing something more meaningful that inspires you.
- Prior to retirement, it is essential to be debt free.
- The adequate corpus size will be annual expenses at the time of retirement* (life expectancy – retirement age) + present value of future lump sum expenses (like kid’s marriage, education etc)
- How long it will take to accumulate adequate corpus depends on your savings rate (as a % of expenses), investment return and inflation.
- How long will the corpus last depends on size of corpus and the real return the corpus will generate.
Disclaimer: The above content is just for information and should not be construed as an offer to buy or sell or recommendation. Contact your financial advisor for guidance on any investment related query.
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