Why Retirement Planning Is Important and How to Go About It

1. 2 out of 5 individuals have not started investing for retirement yet
2. Nearly 1 in 3 urban Indians are worried about their savings depleting within five years of retired life
3. 9 out of 10 respondents above the age of 50 years regret not starting savings earlier for retirement

Source: Max Life Insurance

All the above findings highlight the importance of retirement planning. In this article, we will understand what retirement planning is, its importance and how to do it.

What Is Retirement Planning?

Retirement planning is the process of building a retirement fund during the working years to generate a steady income stream during the retirement years to meet regular expenses till an individual survives. It has two phases: The accumulation phase and the retirement phase.

1) Accumulation Phase

During the accumulation phase, the individual can work with an investment expert who can make a retirement goal plan. As per the plan, the individual can invest a specified amount every month in specified financial products till their retirement (usually 60 years). The investments are expected to grow at an assumed rate of return and help build the retirement fund.

2) Retirement Phase

During the retirement phase, the accumulated retirement fund is invested in specified financial products and generates an expected rate of return. The investment expert can help deploy the retirement fund. The impact of inflation is considered while investing the retirement corpus. The individual can draw a monthly/annual amount from the retirement fund and the remaining amount can remain invested.

During the initial years, the return generated from the retirement corpus may be higher than the annual withdrawal. Hence, the retirement fund amount will grow even after an annual withdrawal. After the initial years, as the annual expenses increase due to inflation, the annual withdrawal amount will be higher than the annual return generated. Thus, the retirement corpus will decrease with every passing year and finally get exhausted at a specified date (usually, the life expectancy is assumed at 80 years).

Why Should You Do Retirement Planning?

Some of the reasons why you should do retirement planning include the following.

1) Income Source During Retirement Years

You will have an active income source only till you keep working. During your retirement years, you don’t want to be working to meet your regular expenses. Hence, you should do retirement planning so that you have an income source during your retirement years to take care of your regular expenses.

2) Financial Independence

Due to a lack of retirement planning, some individuals depend on their children to take care of them during their retirement years. You don't want to be financially dependent on anyone during your retirement years. Hence, it is essential to plan for retirement to be financially independent during your golden years.

3) Take Care of Medical Expenses

During old age, many people are susceptible to illnesses. Hence, you need to be financially prepared for any illness that may strike. You should have adequate health insurance coverage to take care of any hospitalisation expenses. You may also maintain a separate fund to take care of the regular OPD visits to the doctor, diagnostic tests, and medicines not covered by health insurance.

How to Do Retirement Planning?

The retirement planning process involves three steps:

1. Calculating the annual expenses in the first year of retirement
2. Calculating the retirement corpus
3. Building the retirement fund

Let us discuss each of the above steps with the help of an example. Anjali is 41 years old and wants to do her retirement planning. 

1) Calculating the Annual Expenses in the First Year of Retirement

Anjali’s monthly expenses are Rs. 40,000 (annual expenses Rs. 4,80,000). Till the age of retirement (60 years), her annual expenses are expected to grow by 6% p.a. At this rate, her annual expenses at the time of retirement (60 years) will be Rs. 14.52 lakhs (Rs. 14,52,287.76).

During the retirement years, her annual expenses are expected to increase at 5% p.a. Accordingly, her annual expenses in the 61st year will be Rs. 15.24 lakhs (Rs. 15,24,902.15).

Chart: Increase in Annual Expenses

The above chart shows how Anjali’s annual expenses are expected to increase from the current age (41 years) to the first year of retirement (61 years).

2) Calculating the Retirement Corpus

We have calculated Anjali's annual expenses of Rs. 15.24 lakhs in the first year of retirement (61 years). Let us now calculate the retirement corpus that Anjali will need during the 20 years of retirement (age 61 to 80 years), assuming a life expectancy of 80 years. During the retirement years, Anjali's annual expenses are expected to rise by 5% p.a. Anjali will be making an annual withdrawal from the retirement fund and the remaining amount will remain invested. The retirement fund is expected to earn a return of 6% CAGR.

Based on the above numbers, Anjali will need a retirement corpus of Rs. 2.79 crores (Rs. 2,79,13,423.46). 

The table above shows how Anjali will start with a retirement corpus of Rs. 2.79 crores. Her annual withdrawal in the first year (age 61 years) of retirement will be Rs. 15.24 lakhs. The annual withdrawal will increase at 5% p.a. (inflation). The remaining corpus will be invested in debt instruments and earn a return of 6% CAGR.

In the 80th year, Anjali's annual withdrawal of Rs. 38.53 lakhs will match the retirement fund balance, after which the fund will be exhausted.

3) Building the Retirement Fund

In the above section, we calculated Anjali's retirement corpus of Rs. 2.79 crores. Now, let us understand how Anjali can build the corpus. Anjali's current age is 41 years, and she has 20 years to build the retirement corpus. As she has a long investment tenure, she can invest in a mix of large, mid, and small-cap equity funds. It is assumed the investment will earn a return of 12% CAGR.

Chart: Building the Retirement Fund

The above chart shows how if Anjali invests Rs. 3.45 lakhs (Rs. 3,45,896.66) every year for 20 years with an expected 12% rate of return, she will achieve her retirement corpus of Rs. 2.79 crores.

Doing Your Own Retirement Planning

With Anjali's example, we saw how an individual can do their retirement planning. To plan your retirement, you can work with an investment expert and take the following steps.

1) Calculate Future Expenses

Take your current annual expenses and calculate your future annual expenses. While taking the inflation rate, it is better to take a slightly higher rate, so you don't fall short of the retirement fund. Calculate your expenses in the first year of retirement.

2) Calculate the Retirement Fund

Now that you have calculated the annual expenses in the first year of retirement, the next step is to calculate the retirement corpus. An investment expert can help you with the inflation rate and the rate of return for calculating the retirement corpus.

3) Building the Retirement Fund

Once you know the retirement corpus, you can make a goal plan to accomplish it. Based on the amount required, the investment time horizon, and the expected rate of return, the investment expert can calculate the amount to be invested every month. You can start investing through a systematic investment plan (SIP) mode. The investment expert can review the progress once in every six months or annually till the retirement fund goal is achieved.

Retirement Planning: Enjoy the Golden Years With Financial Independence

Retirement is what most people look forward to. During the free time, an individual can choose to socialise, pursue hobbies, travel, work on social causes, etc. But all this will be possible only if you have a retirement fund that can take care of your regular expenses. Hence, it is important to do retirement planning so that you can enjoy the golden years with financial independence.