A reader inquires, “As I approach my 50th birthday this year, I’m contemplating retirement. What steps should I take to determine the necessary retirement corpus for 2023? My yearly expenses amount to approximately Rs. 6.5 lakhs.”
As mentioned in a recent article – I thought a pension was unnecessary, but age taught me a retirement planning lesson! – there are several ways to estimate the retirement corpus required.
The first is what we would like to call a withdrawal rate estimate. Assuming a 50-year-old individual is expected to live until 90 (considering a cautious estimate), they would have 40 years of retirement. With an anticipated inflation rate of 6% and an overall post-tax return from their retirement corpus at 5%, we can use a spreadsheet formula to calculate the required corpus to be approximately Rs. 3.15 Crores.
=PV((1+5%)/(1+6%)-1,40,-650000,,1)
Why such a low rate of return? The entire corpus is being considered, and having excessive equity after retirement is not advisable. Even 40% equity seems somewhat elevated. Therefore, it would be more prudent to assume a return lower than inflation to err on the side of caution.
Why is the corpus so low even though the real return is negative? This is because we are planning for immediate retirement. If this were a 30-year-old, the current expenses of Rs. 6.5 lakhs would inflate to almost 21 lakhs after 20 years (at age 50). Then the corpus required will be about Rs. 10 crores. The above corpus will not change much if the return and inflation estimate change, but the real returns stay the same.
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This is just a rough calculation. We can obtain a more accurate estimate (in this case, a bit lower estimate!) and, more importantly, gain insight on investing the corpus using the freefincal robo advisory tool.
The retirement corpus is assumed to be invested in five buckets. It is important to recognize that the figures below are only an illustration. The robo tool’s output is influenced by numerous factors. Therefore, do not extend these numbers or percentages to your own circumstances without conducting a comprehensive retirement planning analysis.
- An emergency bucket to handle unexpected expenses about 5%: Say Rs. 12 Lakhs
- An income bucket provides guaranteed income for the first 15 years of retirement. About 47% of the remaining corpus, or Rs. 104 lakhs, is invested here. There is no equity exposure in this bucket.
- During this time (first 15 years), investments are made in three buckets: low-risk, medium-risk, and high-risk.
- The buckets will be actively managed to reduce risk: rebalancing and profit booking from one bucket to another. To understand how this works, try The Retirement Bucket Strategy Simulator.
- After 15 years, the low-risk bucket will be turned into 100% debt and provide income for about 11 years. After that, the other buckets will also be progressively used.
- Alternatively, one can manage the buckets so that at all times, 15 years of expenses are always available in the income bucket.
Details of the other buckets are given below.
- Corpus from a low-Risk bucket that provides retirement income from year 16 to year 26. To provide this income, the low-risk bucket will have an asset allocation of 30% equity and 70% debt during the investment period (years 1 to 15 of retirement). About 27% or Rs. 59 lakhs is invested here.
- Corpus from a medium-risk bucket will provide retirement income from years 27 to 34. To provide this income, this bucket shall have an asset allocation of 50% equity and 50% debt during the investment period (year 1 to year 26). About 16% or Rs. 35 lakhs is invested here.
- Corpus from a high-risk bucket will provide retirement income from years 35 to 42. To provide this income, this bucket shall have an asset allocation of 70% equity and 30% debt during the investment period (year 1 to year 34). About 9% or Rs. 19 lakhs is invested here.
The overall equity exposure is only 33%, excluding the emergency bucket and therefore is reasonably safe. The inflation assumed is 6%, the expected post-tax return from equity is 9%, and the expected post-tax return from fixed income is 5% (for bucket investments).
For the income bucket, we have assumed a fixed income return of 5% for the first 25 years and 4% for the last 15 years -all these numbers can be varied at will by the user in the settings page of the robo advisory tool.
The minimum total corpus required for a reasonably comfortable retirement in 2023 is about Rs. 2,30,00,000 (for a 50-year-old with an initial annual expense of Rs. 6.5 lakhs expected to live until age 90). We can round this off to Rs. 2.5 crores.
You may wonder where the current year features in this calculation. It makes its presence felt via our inflation and return expectations. We should repeat this calculation every year before and after retirement to ensure we make the right underlying assumptions.