This is a question many of us ask each other – What is the ideal retirement savings target? What is the retirement corpus I need for retirement? What factors goes into trying to come up with that magic number? To identify the many factors, let us look by dividing the life into two phases 1) Earning/Contribution towards retirement phase 2) Retirement phase (non-active earning phase)
We will cover the aspect of how to plan for retirement in the next blog. We will concentrate simply on the aspect of “What is the ideal retirement savings target” in this blog. So we are only worried about the None active earning period here.
There are dependencies under our control (internal) and some which are out of our control (extraneous). For example monthly expense is under our control to a large extent but tax rate on investments is not under our control. So we make assumptions on some of these dependencies, because the retirement savings value largely depends on these assumptions we make. The key is to use conservative estimates for these assumptions for obvious reasons.
- Monthly expenses
- Number of years alive after retirement
- Inflation
- Returns on investments
- Tax rates
Now we will look at each of these and factors and figure how to come up with an estimate for each of them.
Inflation
Importance of inflation when we are not actively earning, cannot be emphasised enough. The present inflation is easily viewable at GOI website. There is no way for us to know the inflation in the future. But same as present number is a decent start – ~6.5%
Monthly living expenses
If we dont know our monthly expense, the first step to create a retirement plan, is to start budgeting. A simple budgeting exercise, should tell you what is your present monthly living expenses.
Expenses (at retirement) = Present Monthly expenses * (1+inflation rate)^Number of years to retirement
For ex: if you have 10 years to retirement, inflation is 6.5% and present monthly expense is 60K. So,
Expenses (at retirement) = 60,000 * (1+0.065)^10 = ~ 1,13,000 INR
Number of years after retirement
This is obtained from the GOI website to obtain the average life expectancy of an Indian. I would add another 5-10 years to come with a conservative estimate. Based on this, I am going with the life expectancy to be = 72+8 = 80 Years
Returns on investment
My goal during retirement period is to match inflation and not lose purchasing power of my savings. So I would estimate conservatively, with returns of investments slightly better than (or qual to) the inflation. So a conservative return of investments after tax (for simplicity sake) = 7.5%
The final Retirement Corpus calculations
Now that we know the monthly need at the start of retirement, let us calculate the magic number.
Monthly expenses = 1,13,000 INR
Returns on investment = 7.5% and Inflation = 6.5%, so effective rate = (1+inflation)/(1+ROI) – 1 = -0.93%. It is important to understand this -0.93%. This just means that while my expenses at retirement grows at 6.5%, my investments from which my expenses will be covered also grows at 7.5%. So effectively my expenses grow slower than my investments, which is what that -0.93% indicates.
Time period = 20 Years (subtract 80 – retirement age, assuming it to be 60 Years)
Retirement corpus required (using excel) = PV(rate, period, PMT) . = PV ( -0.93/12%, 20*12, 113000) = 2,98,18,750 ~ 3Cr
So for a family which spends 60,000 Monthly expense now, in 10 years to retire making these assumptions – the total Retirement corpus required is approximately 3 Crores! Remember, we have not considered many other life goals or health insurance costs in these calculations 🙂
