Typically, when individuals set their financial objectives, they often conflate retirement goals with other financial aspirations.
Goals such as funding children's education, saving for retirement, and purchasing a house or car are often planned concurrently. While all of these objectives are significant, achieving retirement goals differs from attaining other financial targets.
Many goals can be achieved through loans when sufficient assets are lacking, as financial institutions offer loans based on earnings and work profiles. However, retirement cannot be financed through loans, which many avoid discussing. Goals like children's education have specific timelines, typically 14 to 15 years after starting school, making delays less feasible. In contrast, retirement plans are often postponed for other goals. If funds for education are insufficient, individuals may take loans or withdraw from retirement savings, delaying retirement by years. This postponement can lead to increased financial demands, making it harder to catch up if early benefits are missed.
The retirement goal is unique due to its long accumulation and distribution periods, requiring a significant corpus. While the necessary income for retirement expenses can only be accurately defined close to retirement, the corpus must be built from the start of an individual's working years. Various changing factors complicate estimating this goal, making it crucial to rigorously determine and monitor these variables.
The retirement planning process involves:
Defining the income needed for living expenses post-employment.
Planning how to accumulate the necessary corpus.
Utilizing this corpus to generate income during retirement.
a. Determine expenses in retirement: The first step in retirement planning is identifying retirement expenses, which differ from pre-retirement costs. Key expense categories include housing (utilities, maintenance, taxes), living expenses (food, personal upkeep), medical care, transportation, recreational activities, insurance (life, health, disability), and taxes.
b. Determine income requirement in retirement: When determining retirement income needs, consider factors such as maintaining your standard of living, anticipated expenses, and inflation rates.
c. Time horizon: Time is crucial in retirement planning, particularly for calculating the retirement corpus.
Years to retirement - The timeframe until retirement is the period from now until your retirement age. This duration decreases each year if retirement age stays the same. Understanding the "years to retirement" is essential for planning retirement expenses, as the impact of inflation varies with this timeframe. A shorter period lessens inflation's effect, while a longer timeframe enhances compounding benefits, reducing the amount needed to save for retirement.
Years in/during retirement: The retirement years refer to the duration from the start of retirement until the end of life, which can be estimated based on factors like life expectancy, gender, health, genetics, and lifestyle. Accurately determining this period is crucial for securing sufficient income; underestimating it could lead to insufficient funds during retirement.
d. Determine the retirement corpus: Calculating the retirement corpus is necessary for generating income during retirement requires while taking multiple factors into account.
Let’s say if your annual expense today is Rs 24 lakhs and you plan to retire in 20 years. Post retirement, your retirement life is for another 30 years. What should be the retirement corpus and what should be the monthly investment to accumulate retirement corpus. Assume rate of rate as 12% and inflation as 6%.
When calculating the income required for retirement, it's crucial to account for inflation in current expenses to project their future costs.
In 20 years, living expense will increase due to inflation. 24 lakhs X (1+6%) ^20 = 76.97 lakhs. As you can see, 24L of today becomes ~77L (76.97L) in 20 years due to inflation.
Now the retirement period is 30 years, you need ~77L every year’s inflation adjusted for this period. You will be earning 12% from return. So the net return will be 12% - 6% = 6%.
We apply PV formula in Excel to arrive at retirement corpus.
=pv(6%,30,-77,,) = Rs 10.59 crores is the retirement corpus.
You have 20 years to reach your retirement corpus.
rate = 12% or 1% per month
nper = 20 years X 12 = 240 months
FV = 10.59 cr
=pmt(1%,240,-1059,,) = 1.07 lakhs per month.
As you can see, to achieve retirement in 20 years and generate 24L yearly income, you need to accumulate Rs 10.59 crores in 20 years and for that you need to save Rs 1.07 lakhs per month.
This may look like a complex calculation but if you go through the steps a few times, you will understand it better. Additionally, there are many online calculators to do the same calculation.
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