Retirement Planning - how much do you need?
It’s rather ironic that in spite of the widespread proliferation of pension plans and other retirement savings products available nowadays, a key question often remains unanswered in the minds of even the most resolute savers, that is – “how much do I really need to save for my retirement?”
This brief article will serve as a simple “back of the envelope” calculator for determining this elusive number! For the purpose of illustration, we’ll follow the example of Rahul, a 35 year old married man with children throughout this article.
The concept of “PERP”
“PERP” is an acronym for “Percentage of Expenses for Retirement Planning”. Put simply, if Rahul’s monthly expenses today were Rs. 75,000 and if he were to retire tomorrow, a lot of expenses that he incurs today on a monthly basis would not be borne by him anymore. For instance, his adult children would be well settled and not require schooling or tuition expenses. In addition, he would probably not be paying any car or home loan EMI’s at that stage. A detailed calculation might show that the ‘PERP” for Rahul amounts to Rs. 50,000 in today’s terms or thereabouts. This number would vary from person to person of course.
Inflation – the hidden devil!
Armed with our “PERP” number, we can now go about factoring in inflation into our calculations. Using a ballpark 7% annual inflation number, one can calculate that Rahul’s basic monthly expenses will balloon from Rs. 50,000 per month to Rs. 271,372 per month by the time he retires 25 years later! Inflation will not go “on hold” post retirement either, and these monthly amounts will probably double 10 years into Rahul’s retirement.
Assuming a 10% annual return on the retirement fund and a 20 year “post retirement” life expectancy till age 80, we can work out that Rahul will need to save up a corpus of Rs. 5.1 Crores in the next 25 years to meet his basic PERP expenses after accounting for inflation.
Provisioning for Medical Expenses
Considering that most Senior Citizen medical insurance plans are very expensive, carry a host of exclusions for pre-existing conditions and have a ‘waiting period’ before they come into effect, it would be prudent for Rahul to set aside a separate “medical emergency” fund for himself and his spouse. Although it would be difficult to assign an optimal number for this fund, a round figure of at least Rs. 40 Lacs in today’s terms or Rs. 2.17 Crores at the time of Rahul’s retirement would probably be a wise number to plan for.
Setting up a “leisure” fund
Having worked hard his whole life, Rahul would certainly look forward to spending today’s equivalent of at least 1 Lac per year from the age of 60-70 for traveling and other leisure activities! Once again, factoring in inflation, we can arrive at a figure of Rs. 50 Lacs that would be adequate for this “leisure fund”.
Your spouse might outlive you!
Considering that women typically outlive men by around 5 years worldwide, Rahul may want to provision for an extra 5 years of monthly expenses to the tune of Rs. 25,000 per month in today’s terms for his spouse from age 80-85. This would mean planning at least an additional 25 Lacs of savings by the time Rahul is 60. These 25 Lacs could be invested for 20 years in a long term asset class yielding 12% per annum, growing to Rs. 2.5 Crores by the time Rahul’s spouse turns 80 years old.
What about pension plans?
Pension plans do not adequately solve the retirement planning problem for two reasons. Firstly, they do not factor in inflation – that is, they provision for your future expenditures in today’s terms. We recently encountered a 40 year old client who had taken up a pension plan that would pay him a fixed sum of Rs. 50,000 per month throughout his retirement, and was evidently quite content with it. Only when it was pointed out that Rs. 50,000 per month in the year 2035 was equivalent to a mere Rs. 12,921 in today’s terms, did he actually realize the gross inadequacy of his pension plan! Secondly, pension plans are actually a very low return product – a simple IRR calculation will illustrate that they usually earn only 5-7% post tax returns, which is woefully low when you consider the long term nature of the savings being made!
Adding the numbers together, we arrive at a figure of Rs. 8.02 Crores that Rahul needs to save up by the time he turns 60. This corpus will ensure that he is able to take care of all basic expenses for himself and his spouse, handle medical emergencies, travel once a year and make provisions for the additional 5 years that his spouse is likely to outlive him by. While this might seem like a daunting number, Rahul has time on his side – and by committing 1/5th of his monthly income (which will steadily increase year on year) towards his retirement fund and investing smartly in high yielding asset classes, he can achieve this figure with relative ease. When it comes to retirement planning, it’s important to start early and open your eyes to reality! Understand the importance of this financial goal and treat your retirement fund as sacrosanct. Do not liquidate it to meet other short term goals that might seem more important right now. And most importantly – choose your asset class wisely and be disciplined in your savings habits.