I am confused about how much I need for retirement and how to plan for it

Published: September 20, 2021 at 9:01 am

Last Updated on July 18, 2022 at 9:30 am

A young reader writes, “Hi Sir, I’m 27 years old, recently finished my PG & earning 1.2 Lakhs per month post-tax. Using my first few months salary, I have paid off my UG education loan & a property loan. I have to start paying my PG loan EMI of 35,000 per month from Oct”.

“Currently, I’m building up an emergency corpus of 2.5 Lacs, which is enough for six months family expenses including EMI or 1.5 yrs family expense without EMI. I am saving up for a few other planned purchases as well. Between all this, I will not be able to invest much till March 2022”.

“I don’t have any pre-existing investments or savings except for the mandatory minimum investment in EPF. For FY 20-21, I can only manage investments for tax deductions. I plan to max my PPF for 80C deductions. On the fence about 50,000 in NPS as I don’t want my money locked up till I’m 60”.

“I plan to manage my equity:debt ratio (70:30) through dedicated debt funds. Insurance wise, I have an employer-provided 60 lakhs term plan, five lakhs health cover & 2 lakhs health cover for parents. We also have three old LIC cashback plans, which are in their last 3-4 years term, about which I’m not sure what to do with. I am planning to take a comprehensive health cover & a term plan”.

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“I will be starting my investments from April 2022. I have been reading Freefincal & other blog posts on personal finance to figure out my retirement goals & overall strategy. The retirement corpus I need varies wildly from two crores to 15 crores, depending on where I am checking”.

“I’m writing this mail as I’m confused a bit & want to do this one time planning correctly. How much is required for my retirement & how should I plan for it? Are two equity funds & one debt fund enough for all of my future goals such as retirement, kids education, house etc. or should I get separate funds for each goal? Hope you can help me out”.

Congratulations! You are well aware of the basics of money management at 27. I was ten years older when I got to your stage. Listed below is an action plan.

1. Tax saving for FY 2021-2022: You already have the EPF contribution. You can also claim tax exemption on the interest component of your education loan (section 80E). Buy yourself a solid term plan immediately, and the premium can be used for section 80 C. Therefore, I see no need for any further contribution into PPF (it is not a crime to claim less than 1.5L under 80C!). If the LIC policies are in your name, then they would add up to 80C as well. Since they will mature in the next few years, you can continue them.

Suppose tax-saving bothers you too much (a habit that can wreck your finances), go ahead and invest some money in PPF or VPF (your employer should help with this). However, don’t make it a habit! Note: In the absence of the education loan, it be better for young earners to opt for the new tax regime. This will eliminate the need for 80C based savings.

2: Tax saving from FY 2022-2023: Your desired asset allocation of 70% equity and 30% fixed income will only be delayed if you keep investing in PPF or VPF. Just keep your PPF account alive and consider using an ELSS fund for 80C.

Your asset allocation should always include your EPF and PPF corpus. Your statement “I plan to manage my equity:debt ratio (70:30) through dedicated debt funds.” is incorrect.

If you have some additional money to spare, you include a Nifty or Sensex index funds – see Handpicked List of Mutual Funds July-Sep 2021 (PlumbLine) for fund recommendations.

3 A thumb rule for retirement planning: If X is your monthly expense today, then the total investment for retirement = EPF+ PPF + all mutual funds should be at least 75% of X but preferably 100% of X.

Now anywhere between 50-60% of the total investment should be in equity at your age and the rest in EPF + PPF + any debt fund.

4 Retirement planning is a yearly exercise and not a one-time effort!  Every year your life situation will change, your expenses will change, your income will change (hopefully increase!). So all these factors should be taken into consideration.

5 There are three ways to compute a retirement corpus: a quick order of magnitude estimate, a rough calculation or a more realistic calculation. I will discuss the quick estimate here.

If X = monthly expense today that will continue for life, then at 7% inflation, it will double every 11 years. So after 22 years, when you are almost 50, your current monthly expense will inflate to about 5X (rounded off to be on the safe side).

You can now appreciate why retirement planning is an annual exercise – X will change every year due to inflation of old expenses (which can be factored in) and lifestyle changes.

So the annual expense at age 50 = 12 times 5 times X = 60X. Age 50 is the new 60! See: How to prepare for the “new normal” in retirement planning.

Now assuming a 50-year-old will live up to age 90, the inflation after retirement is 6% and return on the portfolio after tax is also 6% (zero real return), the corpus required (approximately) is 40 times the annual expense in the first year of retirement.

That is 40 times 60X = 2400 X. So if X today is Rs. 25,000, the approximate corpus is about Rs. 6 crores.

However, aiming for zero real return over 40 years is unrealistic and quite simply wrong (I know young people think this is nonsense but something hit you only when you get older). That is, a full-fledged calculation based on retirement buckets becomes necessary. An example of the full calculation is available here: I am 30 and wish to retire by 50; how should I plan my investments?

Now, assuming you can invest Rs. 25000 a month from April 2022, and that you can increase this investment by 10% a year (this is crucial); for a portfolio return of about 9% after-tax, the corpus will be close to 5 crores after 22 years. Obviously, higher investment and a long tenure will increase the corpus.

Please note, the equity allocation mentioned above should not be retained the same for the entire duration. It has to be systematically varied well before retirement. So the portfolio return assumption will also keep changing.

Finally, as regards using the same or different mutual funds for different goals, it is a matter of personal choice and comfort. I recommend different mutual funds as IMO simpler and easier to manage (more is not always bad), but you can consider an alternative opinion here: How I manage my money using the unified portfolio approach.

In summary, our young earner should sort his situation by April 2022 as planned and start investing rigorously. A term plan and health insurance should be purchased immediately. Unnecessary investment in PPF or VPF should be avoided. He should aim to invest an amount equal to or higher than his monthly expenditure. If this is not possible, then means of increasing income should be explored.

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Pattabiraman editor freefincalDr 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.
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