We cannot fight inflation after retirement by protecting our nest egg!

Published: May 12, 2021 at 10:55 am

We had recently discussed why we need to stop using Safe Withdrawal Rate (4% rule) for retirement planning. Many readers seem to be under the wrong impression that it is possible to fight inflation after retirement while ensuring the principal (nest egg) does not deplete. Here is why this is wrong.

Let us reproduce the example discussed in the safe withdrawal rate discussion. Suppose you have a corpus of Rs. one crore upon retirement. You invest in such that it gets you 7% overall return after tax every year in retirement. This is far from an easy achievement, but let us play along. Assume that the inflation is 7%. That is your expenses will increase each year by 7%. No sudden increase in expenses is accounted for.

So the one crore is invested, and each year, you withdraw an amount equal to current annual expenses from it. Let us assume your expenses in the first year of retirement are Rs. 4 lakh. Now the withdrawal rate in the first year of retirement is 4%, that is 4 lakh divided by 1 crore = 4%.

In the second year, the expenses are Rs. 4.28 lakh (7% inflation), and the corpus after the first year withdrawal, has grown by 7% to Rs. 1.0272 Crores (Rs. 102.72 lakhs). The withdrawal rate in the second year of retirement is 4.28/102.72 = 4.17%. We discussed in the previous article how the withdrawal rate keeps increased and the idea of a safe or sustainable withdrawal rate is a reference only to the initial withdrawal rate (first year).

Many readers have argued that this reasoning is wrong. According to them, the corpus earns a 7% return each year and the inflation is also 7%. So this means the retiree is only withdrawing the interest and the principal or nest egg will always be one crore and protected. This way the withdrawal rate is always 4%.


On the face of it, this seems right does it not? Not quite.  Suppose I invest Rs. one crore in a product that gives me a 7% return each year. The first year I will get 4 lakhs as interest which I will use as expenses. In the second year?

I need Rs. 4.28 lakh for expenses. Will this product give me 4.28 lakh in the second year, Rs. 5.24 lakh in the fifth year and so on? Or will it give the same Rs. 4 lakh each year? Obviously no. In order to handle inflation, we need to dip into the principal. There is no other way.

Yes, there are increasing annuity products available. That is, you pay the one crore to a life insurer and they will pay you a pension for life that increases each year. The catch is, the rate of increase is only 3% (before tax!) and the interest rate for this option would be much lower than the interest rate for the constant pension option. This option is unsuitable in more ways than one.

If the retiree wants to protect the capital, then they cannot aim for higher income in the future and keep pace with inflation. If they want to keep pace with inflation, then they will have to dip into the nest egg. There is no other way. To reiterate, this 4% SWR rule refers only to the initial withdrawal rate.

Also beating inflation is not the only goal in retirement. The retiree will have unexpected expenses and also discretionary expenses. There should be ample buffer in the corpus for these. That is why I keep

Think of retirement income distribution as running a marathon. The goal is not to win but to finish the marathon. A retiree having high expenses or a low corpus will have a high initial withdrawal rate. This is like a person starting a marathon at high speed. They are unlikely to finish.

Just like correct pacing is essential to complete a marathon, retirement income distribution requires as low an initial withdrawal rate as possible. It is not much of an analogy but you get the picture. If we withdraw too much too soon, the corpus will run out.

Young earners and early retirement aspirants should focus on not only building a large nest egg, but they must also plan out their retirement bucket strategy and how they are going to tackle the sequence of returns risk. If this is in place, the initial withdrawal rate can be kept under control. See: Can I Retire With Rs. One Crore Today?

Also see: Want to be financially free? Do not count on frugality! Worry about the sequence of returns risk!

Do share if you found this useful

Use our Robo-advisory Excel Template for a start-to-finish financial plan! Now with a new demo video!  More than 640 investors and advisors use this!
Our flagship course! Learn to manage your portfolio like a pro to achieve your goals regardless of market conditions! More than 2525 investors and advisors are part of our exclusive Facebook Group! Get clarity on how to plan for your goals and achieve the necessary corpus no matter what the market condition is!! Watch the first lecture for free!  One-time payment! No recurring fees! Life-long access to videos in an exclusive Facebook Group! Reduce fear, uncertainty and doubt while investing! Learn how to plan for your goals before and after retirement with confidence.
Our new course!  Increase your income by getting people to pay for your skills! More than 585 salaried employees, entrepreneurs and financial advisors are part of our exclusive Facebook Group! Learn how to get people to pay for your skills! Whether you are a professional or small business owner who wants more clients via online visibility or a salaried person wanting a side income or passive income, we will show you how to achieve this by showcasing your skills and building a community that trusts you and pays you! (watch 1st lecture for free). One-time payment! No recurring fees! Life-long access to videos in an exclusive Facebook Group!   
My new book for kids: “Chinchu gets a superpower!” is now available!
Both boy and girl version covers of Chinchu gets a superpower
Both boy and girl version covers of Chinchu gets a superpower.
Most investor problems can be traced to a lack of informed decision making. We have all made bad decisions and money mistakes when we started earning and spent years undoing these mistakes. Why should our children go through the same pain? What is this book about? As parents, if we had to groom one ability in our children that is key not only to money management and investing but for any aspect of life, what would it be? My answer: Sound Decision Making. So in this book, we meet Chinchu, who is about to turn 10. What he wants for his birthday and how his parent’s plan for it and teach him several key ideas of decision making and money management is the narrative. What readers say!
Feedback from a young reader after reading Chinchu gets a Superpower (small version)
Feedback from a young reader after reading Chinchu gets a Superpower!
Must-read book even for adults! This is something that every parent should teach their kids right from their young age. The importance of money management and decision making based on their wants and needs. Very nicely written in simple terms. - Arun.
Buy the book: Chinchu gets a superpower for your child!
How to profit from content writing: Our new ebook for those interested in getting side income via content writing. It is available at a 50% discount for Rs. 500 only!
Did you know? We have more than 1000+ videos on YouTube to explore! Join our YouTube Community!

Want to check if the market is overvalued or undervalued? Use our market valuation tool (will work with any index!), or you buy the new Tactical Buy/Sell timing tool!
We publish mutual fund screeners and momentum, low volatility stock screeners .every month.
About the Author Pattabiraman editor freefincalM. Pattabiraman(PhD) is the founder, managing editor and primary author of freefincal. He is an associate professor at the Indian Institute of Technology, Madras. since Aug 2006. Connect with him via Twitter or Linkedin Pattabiraman has co-authored three print books, You can be rich too with goal-based investing (CNBC TV18), Gamechanger, Chinchu Gets a Superpower! and seven other free e-books on various money management topics. He is a patron and co-founder of “Fee-only India,” an organisation to promote unbiased, commission-free investment advice. He conducts free money management sessions for corporates and associations based on money management. Previous engagements include World Bank, RBI, BHEL, Asian Paints, Cognizant, Madras Atomic Power Station, Honeywell, Tamil Nadu Investors Association, IIST Alumni Association. For speaking engagements, write to pattu [at] freefincal [dot] com
About freefincal & its content policy Freefincal is a News Media Organization dedicated to providing original analysis, reports, reviews and insights on developments in mutual funds, stocks, investing, retirement and personal finance. We do so without conflict of interest and bias. Follow us on Google News. Freefincal serves more than three million readers a year (5 million page views) with articles based only on factual information and detailed analysis by its authors. All statements made will be verified from credible and knowledgeable sources before publication. Freefincal does not publish any paid articles, promotions, PR, satire or opinions without data. All opinions presented will only be inferences backed by verifiable, reproducible evidence/data. Contact information: letters {at} freefincal {dot} com (sponsored posts or paid collaborations will not be entertained)
Connect with us on social media
Our publications

You Can Be Rich Too with Goal-Based Investing

You can be rich too with goal based investingPublished by CNBC TV18, this book is meant to help you ask the right questions, seek the correct answers, and since it comes with nine online calculators, you can also create custom solutions for your lifestyle! Get it now. It is also available in Kindle format.
Gamechanger: Forget Startups, Join Corporate & Still Live the Rich Life You Want Gamechanger: Forget Start-ups, Join Corporate and Still Live the Rich Life you wantThis book is meant for young earners to get their basics right from day one! It will also help you travel to exotic places at a low cost! Get it or gift it to a young earner.

Your Ultimate Guide to Travel

Travel-Training-Kit-Cover-new This is an in-depth dive analysis into vacation planning, finding cheap flights, budget accommodation, what to do when travelling, how travelling slowly is better financially and psychologically with links to the web pages and hand-holding at every step. Get the pdf for Rs 199 (instant download)
Free android apps