If you do not have a guaranteed pension for life, your biggest fear of retirement may be “What if the money does not last for life”. So, it is necessary to have a plan in advance for retirement years.
During a normal discussion on personal finances, Amit told Mohan that though he is saving for retirement, which is far away. Still, he does not know, how many years of retirement you should plan for. It is very difficult to look at 20-30 years of retirement. What if, saved money would not be sufficient for life, given the inflation?
This question is generally very difficult to answer because you do not know, how long you will live. Still, you can estimate the years of retirement and then you can chalk out a plan.
Estimating years of Retirement
Though it is not easy to accurately predict the number of years in retirement, still you can put in a rough estimate. This estimate could be based on general life expectancy, your present health, medical support systems in your neighborhood, and other factors. I know it is difficult to make such an estimate.
Recently, J. P. Morgan in a study showed that a person has about 83% chance of living till 75, about 50% chance of living till 85, 28% chance of living till 90, 11% chance of living till 95, and 2% chance of living till 100.
Assuming you do not have any life-threatening health issues, you can safely say that there are 25-28% chance of living till 90 years. Now you can plan around this estimated life.
You also need to decide about the age of retirement. Say, if you retire at the age of 55 years, you need to plan for 35 years of retirement (till the age of 90).
Estimating Retirement Corpus
You will need money to support you for about 35 years (a long time). You need to ensure that money does not run out. 35 years is a long time and inflation may have a critical impact on your plans. There have been several studies, that indicate that if you withdraw 3% to 4% annually from retirement corpus, adjusted for inflation, it will sustain you for your life. This is called the Safe Withdrawal Rate.
If you choose the 4% Safe Withdrawal rate, then you need to multiply your annual expenses by 25 to arrive at an estimated retirement corpus amount. For example, if you need 1 lakh for monthly expenses at retirement, then for 12 lakh annual expenses, 3 crores (12 lakh X 25) would be required in retirement corpus.
In the above example, monthly expenses of 1 lakh are estimated at retirement age. It also means that if you want to retire today with 1 lakh as monthly sustenance expenses, then you would require at least 3 Crores.
But only sustenance expenses are not enough. You also need to account for some big expenses that may fall after retirement, such as higher education of kids, marriage of kids, healthcare expenses, etc. The same needs to be added to arrive at the corpus needed at the time of retirement.
Keep an Eye on Inflation
To avoid the situation, where your corpus may run out, you need to keep a watch on inflation. You may need to adjust your expenses if the remaining corpus seems insufficient. If you are getting an average return of about 8% on your investments, while you withdraw 4% annually, you will have a surplus of 4%. This surplus can be used for additional expenses. If you are generating returns through equity, you need to decide surplus based on 3 years’ returns, because equity markets may also give negative returns in any year.
Keeping Things Simple
Once-a-year review is sufficient for this plan. You can do this on January 1st or your birthday. Based on returns earned over investments and prevailing inflation, you can decide about the withdrawal amount for next year. You can withdraw the annual expenses and deposit them into a liquid fund. From liquid funds, a Systematic Withdrawal Plan (SWP) instructions will deposit the amount automatically in your bank account monthly.
With proper planning in advance, you can estimate the required corpus amount. The earlier you plan, you will have sufficient time to fund your corpus with savings and investments. Remember, you can not plan for retirement, if it is tomorrow.