How to estimate retirement corpus - What is retirement planning - ArthikDisha

How to estimate retirement corpus

How to estimate retirement corpus

If we analyse India’s current demographic conditions in 2018, we would find that 41.08% of the total population belongs to 25 to 54 Years age bracket i.e. around 52.65 Crores people and 17.90% of the population belongs to 14 to 24 years age bracket i.e. around 23.94 Crores people. So, it is very much evident that for the next few years there is going to be a great amount of investment in retirement products. So, this has really prompted me today to write a blog post on How to estimate retirement corpus. This post would definitely help the young generation of India to find a better way for how to estimate retirement corpus. This will also help them in taking an informed decision regarding retirement wealth creation.

What is retirement planning – How to estimate retirement corpus

Retirement planning is a process to estimate the retirement corpus and to ensure adequate income after retirement to meet the monthly expenses of an individual. Therefore, retirement planning basically involves two components i.e. estimation of the retirement corpus and ensuring adequacy of retirement corpus to generate regular monthly income after retirement.

Estimation of retirement corpus will depend on how much income is required to provide for the expenses at retirement. There are actually two stages in retirement i.e. The accumulation stage and the distribution stage.

How to estimate retirement corpus:

Estimating retirement corpus is a part of the retirement planning process. Estimation of retirement corpus solely depends on the amount of income that has to be generated on regular basis to meet the monthly expenses at retirement. So, while planning for retirement one needs to ask himself the following two questions.

  • How much income is required on regular basis to maintain the same standard of living? (Income estimating)
  • What will be adequate retirement corpus to generate this monthly income? (Retirement Corpus determining)

Income estimating

Estimating Income requirement primarily involves two methods namely; Income Replacement method and Expense Protection method.

  • Income Replacement method: Under this method, the monthly income required at retirement is calculated based on the ratio of current monthly income. So, in this method, the future post-retirement income is calculated based on current income and after adjustment for certain expenses like PF deduction from salary, payment of taxes, office conveyance cost, money set aside for financial goals and alike expenses.

Factors to be considered for determining future retirement income under the Income Replacement method:

Calculation of current income; (Income)

The expected rate at which the income is likely to grow over the periods to retirement;(Growth rate)

Calculate the years to retirement;( No. of years)

Calculation of income at the time of retirement at current level i.e. Current income*(1+Growth rate)^ No. of years to retirement;

Apply the income replacement ratio.

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Now, let’s take an example for easy understanding.

Mr. Koushik is earning currently a  monthly income of ₹50000 and ₹600000 annually. He is 35 years old and is expected to retire at the age of 60 years. His income is expected to grow at a rate of 10%. He anticipates that his income replacement ratio to be 75%.  What annual income will Mr Koushik require at retirement?

Income Replacement Method
Current Annual Income ₹600,000.00
Age 35
Retirement age 60
Years to retire 25
Annual Growth rate 10%
Income at the time of retirement ₹6500823.566 ₹600000*(1.10)^25
Income replacement ratio 75%
Annual income required at retirement i.e. after 25 years from now ₹48,75,617.675 ₹6500824*75%
  • Expense Protection method:

Under this method, the main purpose is to identify and estimate the expenses that are likely to be incurred at retirement. Primarily the expenses required at retirement is a certain percentage of just pre-retirement expenses. Here one needs to make certain assumptions that some expenses are not going to occur like home loan EMI. At the same time, some mandatory expenses are going to rise significantly like health cost. Some experts consider this method a little bit complex due to the detailed listing of all expenses. Most importantly, all the future expenses have to be adjusted for inflation over the period of time for retirement to calculate the expenses at retirement.

Now, let’s take an example for easy understanding.

Mr. Koushik is earning currently a  monthly income of ₹50000 of which 60% is household expenses. He is 35 years old and is expected to retire at the age of 60 years. He anticipates incurring additional ₹20000 per month as discretionary expenses at retirement.  If the inflation rate is 6%, what is the expense at retirement?

Expense Protection Method
Current households expense ₹30,000.00 60% of 50000
Additional discretionary expense at retirement ₹20,000.00
Total retirement expenses ₹50,000.00
Years to retire 25
Inflation rate 6%
Expenses at the time of retirement ₹2,14,593.54 50000*(1.06)^25

Now, just consider the expected inflation rate as 7%, the expense at retirement would be ₹2,71,371.632. Just for 1% change in the inflation rate, the monthly expense at retirement is growing by ₹56,778. This is quite interesting.

Determination of Retirement Corpus – How to estimate retirement corpus

I have already mentioned that retirement planning goes through two steps. After estimating income the next step is determining how much corpus is required to generate that income.

Factors to be considered for determining the retirement corpus

Periodic income recognition;

The expected inflation rate;

The rate of return to be generated by the corpus;

Life expectancy i.e. for how many years the regular income is to be generated by the corpus;

How inflation impacts your retirement corpus

While determining the retirement corpus one of the most crucial factors that has to be kept in mind is Inflation. In my opinion, most of the retired persons are scared of the one monster and that is inflation. I do think that there is enough valid reasons for them to get scared. Because if you don’t consider inflationary effect properly, your retirement corpus would prove to be inadequate within few years of retirement. Income estimated as per above two methods I have already discussed is not going to remain same just even after five years of retirement.

Inflation reduces your purchasing power of money over time. It increases the prices of goods and services we consume on a daily basis. This means now you would not be able to purchase something with the same amount of money as you could purchase earlier. But unfortunately, we only consider the inflationary impact for cost of living expenses but what about other impacts such as the increase in health cost, travel cost which generally increase at a higher speed.

How to estimate retirement corpus

This is very interesting to know that if your investment is earning 8%  return annually and the inflation rate is 6%, your effective earning or inflation-adjusted earning will be 1.89%. This is called the real rate of return. It is calculated as below.

Inflation-adjusted Return= (1+ Nominal Return)/(1+Inflation Rate)-1

(1+.08)/(1.06)-1  = 1.89%

Now, let’s take an example to calculate retirement corpus

Mr. Koushik requires a monthly income of 50000 at today’s value for his retirement after 25 years at the age of 60 years. His expected life is 80 years. Calculate the retirement corpus that Mr. Koushik will require at retirement to meet his expenses. His bank deposits would fetch him a yield of 8% whereas the rate of inflation is 6%.

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How to estimate retirement corpus-

As I have already mentioned that this calculation would go through two steps. One is income calculation at retirement and the other one is calculation of retirement corpus.

Step 1.

Calculation of income at retirement
Income required at current value ₹50,000.00
Time for retirement 25 years (60-35)
Inflation rate 6%
Income required at retirement ₹214,593.54 50000*(1.06)^25

Step 2.

Calculation of retirement corpus
Income required at retirement ₹214,594.00
Expected life after retirement 20 years
Rate of return on corpus 8%
Inflation rate 6%
Inflation adjusted return 1.89% (1.08)/(1.06)-1
Retirement corpus (Present value) ₹42,859,626.82 PV(.189/12,240,-214594,1)

So, from the above calculation, you can see that the retirement corpus required is ₹42,859,626.82 after 25 years from now to generate inflation adjusted income of ₹214,594.00 for 20 years post retirement.

Final word on How to estimate retirement corpus

I hope that I have done enough justice on today’s topic How to estimate retirement corpus. It has been my continuous endeavour to keep things very simple so that even a layman can understand all the financial terms used here and that would facilitate them to take an informed decision and know how to estimate retirement corpus. If you like my blog post kindly comment in the box below and share with your friends as much as you can.

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