Catch-22 Retirement Planning!

A catch-22 situation is one from which there are no easy solutions. Any move we make will be associated with significant disadvantages and risk. Such situations are often found in retirement planning. Whether you are a middle-aged employee heading towards retirement or a young earner trying to manage their parents’ retirement fund, understanding when a catch-22 can arise is important.

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Consider a couple that requires Rs. 2.5 Lakh (2,50,000) at the start of their retired life. We will assume that their expenses will increase at only 6%. If we assume a 100% conservative interest rate of 7% (post-tax) and assume that they will both live for next 20 year (only!), using the Four Simple Retirement Planning Tools one can calculate that the corpus required is: Rs. 45.8 Lakhs.

If they this much or more, there is nothing to discuss further. A very common situation is that many have less, much less.

What if they had only 50% of required corpus: ~ 23 Lakhs?

Then, assuming inflation is still 6% and interest rate is still 7%, if they keep withdrawing money from the corpus each year, it will only last less than 10 years:

If the corpus is less and the investments do not yield much, there is a danger of running out of money to live on.

If we insist, the money should last for 20 years with 6% inflation, the corpus should be invested such that the return is 17%! Now that might seem ridiculous to anyone with comonsense but some suggest 100%  equity after retirement and also expect that much (or more!) returns!

Obviously expecting 17% returns from the entire corpus is far from realistic. This is possible only if one invests in volatile instruments. This means taking on more risk.

If a retiree takes on risk in the hope of achieving more returns, they might end up reducing the corpus fast!

It is extremly important to understand that there is not such thing as a notional loss for a retiree. Any significant loss in the market could take years to overcome and in the meanwhile the retiree will be drawing more and more from a depleted corpus.

No risk taken with a low corpus implies it will not last long.

High risk taken with a low corpus with the hope of making it last longer could deplete it faster than the above option!

damned-if-you-do-damned-if-you-dont

I hope you can see the catch-22 situation forming. How much risk is just right is practically impossible to answer. Especially because most of the retirees today will not have experience with volatile instruments like mutual funds. They might get sacred and exit at the wrong time making further damage.

If a retiree has 10% equity exposure, it may not be enough to make a difference. Increase this and it will rapidly increase the risk or the maximum loss one will have to bear. Read more: Asset allocation for long-term goals.

I have discussed a case (commonly seen) where the corpus is only 50% of what it should be. In such cases, the only solution is to purchase an annuity and lock-into a fixed interest rate for the retiree. This is far from ideal, but would at least guarantee some income for life. It however cannot account for large unforseen and recurring expenses that a retiree couple may incur.

If the available corpus is 75-80% of what it should be then “some” risk can be comfortably taken. How much is that “some” is again difficult to quantify.

In an earlier posts, I had come up with a simple set of rules reg. When should senior citizens purchase an annuity? Do give this a try and let me know what you think.

Also everything you wanted to know about how Annuity Plans Work can be found here.

 

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About the Author M Pattabiraman author of freefincal.comM. Pattabiraman is the co-author of two books: You can be rich too with goal based investing and Gamechanger. “Pattu” as he is popularly known, publishes unbiased, promotion-free research, analysis and holistic money management advice. Freefincal serves more than one million readers a year with numbers based analysis on topical issues and has more than a 100 free calculators on different aspects of insurance and investment analysis, including a robo advisory template for use by beginners. Contact information: freefincal {at} Gmail {dot} com He conducts free money management sessions for corporates (see details below). Previous engagements include World Bank, RBI, BHEL, Asian Paints.

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Updated: October 14, 2016 — 12:42 pm

2 Comments

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  1. Hi Pattu, Which annuity give good interests? I think FDs might give better interests compared to any annuity. Is my assumption correct?

    1. Annuity rates are locked for life and FD rates can vary with rate cycles.

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