Last Updated on February 12, 2022 at 6:22 pm
We received this question on how to generate monthly income that handles inflation from a retirement corpus. “Hi, Pattu Sir, I read about reaching 45x annual expenses in this article: How I plan to achieve financial independence and move to my native place. Considering this as a thumb rule, I have a query. Assumption: My current monthly expenses is 1 Lakh rupees – 45X = 12 x 1 lakh x 45 = 5.4 Crore”.
“Let us assume I have this corpus in the form of Equity or MF or Property Value today – Does this require liquidation and put this 5.4 Crore fund into a Debt / Equity – Dividend mix funds to get the monthly income required? Sorry for the basic doubt, How do I get the 1 Lakh rupees I need per month today, and this will increase over time with inflation. Kindly advise. The goal would be to reach 45x annual expenses to consider myself financially independent”.
While investing for a retirement that is several years away, the goal will be to have 50-60% of the portfolio in equity and the rest in fixed income. After retirement, the accumulated corpus will be distributed among several buckets. This distribution has to be done gradually in the last decade or so before retirement. The tax incidence of shifting from equity to fixed income or from one fixed income instrument to another is minimised this way or at least spread out.
As an example, Let us punch this scenario into the freefincal robo advisory template. We will assume the person is 45 years of age, has the 45X corpus and is ready to retire. Another example is an earlier article: How much do I need to retire by 45 in India?
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Assumptions:
- Age of the investor: 45
- Years in retirement: 45 (life expectancy is age 90)
- Monthly expenses in the first year of retirement: Rs. one lakh. So the assumed annual income in the first year of retirement is Rs. 12 lakhs.
- Inflation during retirement is 6%. This means the annual income will increase by 6% each year for 45 years.
- Corpus in hand = 45 times the current annual expense of Rs. 12 lakhs = Rs. 5.4 crores. There is no other source of income (the template can handle three sources of increasing income from rent or pension)
The retirement corpus is assumed to be invested in five buckets.
- An emergency bucket to handle unexpected expenses.
- Income bucket providing guaranteed income for the first 15 years in retirement.
Note: When referring to drawing income, we assume the amount withdrawn on the first day of each year in retirement will be 6% higher than the previous year to account for inflation. For the first year we withdraw Rs. 12 lakhs and for the next year, 6% more or Rs. 12.72 lakhs and so on.
- During this time, investments are made in the following three buckets.
- Corpus from a low-Risk bucket that provides income from year 16 to year 26 in retirement. To provide this income, the low-risk bucket will have an asset allocation of 30% equity 70% debt during the investment period (years 1 to 15 of retirement).
- Corpus from a medium risk bucket will provide income from year 27 to 35 in retirement. 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)
- Corpus from a high-risk bucket will provide income from year 36 to 45 in retirement. 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 35)
That is, the retirement corpus will be divided into five parts. Overall asset allocation excluding the emergency bucket: 68% fixed income and 32% equity.
The investor must gradually shift from 50-60% equity to 32% (as per the inputs in this example) in the last decade or so before retirement. See a full example here: I am 30 and wish to retire by 50; how should I plan my investments?
- 5% in an emergency bucket
- 45% in an income bucket will provide guaranteed risk-free income inflation-protected income for the first 15 years. The rest of the parts will be invested in three buckets: low-risk (25%), medium-risk (13%) and high-risk (11%) in the asset allocations indicated above. The buckets will be actively managed to reduce risk during this investment period: rebalancing and profit booking from one bucket to another. To understand how this works, try this: 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. One can always customize this usage after retirement.
This is a schematic from a previously published illustration: Creating a retirement income plan for 27-year old Amar. Please note that bucket allocations will change as per the age profile of the user. So the numbers shown in the figure will vary from what is presented above.
In summary, investors need to plan in terms of the bucket strategy today when their retirement is years or even decades away. That way, they can efficiently and systematically manage the risk associated with the retirement corpus by gradually shifting it from an accumulation-type asset allocation to an income distribution-type asset allocation.
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Dr M. Pattabiraman(PhD) is the founder, managing editor and primary author of freefincal. He is an associate professor at the Indian Institute of Technology, Madras. He has over ten years of experience publishing news analysis, research and financial product development. Connect with him via Twitter(X), Linkedin, or YouTube. Pattabiraman has co-authored three print books: (1) You can be rich too with goal-based investing (CNBC TV18) for DIY investors. (2) Gamechanger for young earners. (3) Chinchu Gets a Superpower! for kids. He has also written seven other free e-books on various money management topics. He is a patron and co-founder of “Fee-only India,” an organisation promoting unbiased, commission-free investment advice.Our flagship course! Learn to manage your portfolio like a pro to achieve your goals regardless of market conditions! ⇐ More than 3,000 investors and advisors are part of our exclusive community! Get clarity on how to plan for your goals and achieve the necessary corpus no matter the market condition is!! Watch the first lecture for free! One-time payment! No recurring fees! Life-long access to videos! Reduce fear, uncertainty and doubt while investing! Learn how to plan for your goals before and after retirement with confidence.
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