How an indexed pension makes a huge difference to a retirement plan

While preparing a slide deck for a talk at the Reserve Bank Staff College, I made a bespoke retirement calculator that factors in an indexed pension. Here is how that makes a huge difference to a retirement plan.

An indexed pension increases each year at a set rate or inflation rate. This is known as dearness relief. Until a few years ago, RBI employees had no dearness relief and only had a constant pension. Then, indexation was introduced. This is similar in structure to the unified pension scheme.

The freefincal robo advisor users can include up to three indexed income sources (pension, rent, dividends, etc.) while planning for retirement.

Let us look at an example. There are several conservative assumptions in estimating the pension and other aspects of the retirement plan here.

Age at the end of the current year: 31
No of years you expect to work: 29
Current expenses per month (annual/12): Rs. 60000
Expected inflation before retirement: 6.00%
Expected inflation after retirement: 5.00% (this is perhaps a touch low, but I had to set it at 5% so that it approximately matches the pension indexation. This allows me to avoid macros/scripts in the Excel file)
Estimated years in retirement: 25
The average rate of return (after tax) expected before retirement: 9.00% (this a crude approximation)
Anticipated post-retirement rate of interest (after tax): 6.00%
The tool also factors in investments made in three different asset/tax types and their future value
Annual increase in monthly investment: 5.00%
Current monthy Basic pay: Rs. 50,000
Approximate basic pay at the time of retirement: Rs. 2,70,919 (salary increase ~ 6% a year, factoring in increments, promotions and pay commissions)
Approximate monthly pension at retirement: 2,25,766 (half of last drawn basic + 1/3rd of last drawn basic as DA). This is probably the most contentious assumption, as we do not know the DA rate at the time of retirement.
Annual pension before tax Rs. 27,09,194
Annual pension after tax Rs. 22,09,725 (assuming current new tax regime rates)
Monthly post-tax pension Rs. 1,84,144
Monthly expenses in 1st year of retirement Rs. 3,25,103
Net monthy income reqd from the corpus in 1st year of ret Rs. 1,40,959
Total retirement corpus required: Rs. 3,78,29,519
Net corpus to be saved Rs. 3,17,43,428 (factoring in some current investments)
Initial monthly investment required 12,050 (to achieve the net corpus).

Illustration of retirement planning with an indexed pension

In this illustration, the gap between expenses and the indexed pension is handled using a bucket strategy using the Rs. 3.78 Crore corpus.

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For some illustrations, see:

Retirement Plan without any pension

Suppose we set the pension to zero. We have:

Total retirement corpus required Rs. 8,72,48,475
Net corpus to be saved Rs. 8,11,62,384
Initial monthly investment required Rs. 30,810

That is a 131% increase in the total corpus and a 156% increase in the initial monthly investment required.

If the pension were constant throughout retirement without indexation, the total corpus required would be Rs. 5.73 Crores, the net corpus (considering the same investments) would be Rs. 4.49 Crores, and the initial monthly investment required to achieve this net corpus would be Rs. 17K.

Thus, an indexed pension makes a considerable difference to a retirement plan. It also significantly increases the government’s pension burden.

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