Rules of retirement planning: Key things to know

Times of India 11/12/2019

NEW DELHI: Do I have enough money to retire? This is the most asked question in retirement planning. When I wrote about the need to take charge in your 40s, friends asked for a method to evaluate whether they have enough. Let’s consider some pointers.

How much is enough is a tough question to answer. If someone spends ₹50,000 a month on an average, in current rupee terms, and if we assume that such a person will live 30 years into retirement, we can use a thumb rule to ask if they have a retirement corpus of ₹50,000 x 12 x 30, or ₹1.8 crore. Purists will argue we have not considered inflation. We can counter argue, we have also not considered the growth in corpus. Since we are not going to use up the ₹1.8 crore in one shot, but use only a part of it, we would invest the rest and thus it will appreciate.

There are three primary challenges in retirement planning. The first is whether our corpus is invested well to grow aggressively. The second is whether our income needs in retirement are well thought through and provided for. The third is whether the amount we draw from the corpus and the amount we keep invested are well balanced.

Consider the retirement saving challenge. Many believe that the contribution to PF is a good way to save. However, the biggest pitfall of this investment choice is that it is a long-term investment meant to appreciate in value over time, but is mistakenly invested in income assets that generate a defined return.

While we may not able to change the PF rules, we can apply the principles of diversification to the rest of our savings. A simple index fund or ETF —a Nifty-based or Sensex-based product—is the simplest, easiest and lowest cost route to building a default retirement corpus.

Second is the question of income needs in retirement. Owning a house by the time one retires is a good plan to keep rents in check. The mix of expenses will change in retirement: you might spend more on new interests; on travel and tourism; on health and medicare. It is not always easy to estimate these expenses, and some of them may be unexpected. The limit to our expenses is set by the third factor in that list.

The third element in retirement planning is the much-feared draw down. What this means is the amount of the corpus we will actually end up spending in retirement. The simplistic assumption many make is that they will invest the corpus, and live on the interest it earns. That is a harmful thinking in at least three ways: One, you leave the corpus unchanged in value, investing it to generate income for a long period of 30 years. Such a long-term asset should be invested better. Second, you use the income and leave behind the principal. That might not be the ideal plan. Your children may not need that largesse. Three, you don’t use all that money when you draw on it, so obsessing about keeping the corpus intact is actually foolhardy.

View your corpus as one large pool. You draw some of it—income or growth won’t matter—and you let the rest stay invested and grow in value. If your corpus is ₹1 crore and your annual expense is ₹6 lakh, you are drawing down 6%. That is quite a large number, and you may run out of it soon. Keep that number small, at 3-4%. That thumb rule at the start is based on this math: When you apply that simple rule of 30 times your spend as your corpus, ensure it is available to use as we just elaborated. If that wealth is locked in your house, you save on rent, but earn no income. That won’t help. Hence that 30% rule: 30% of your money in the property you have anyway bought; 30% in equity for appreciation and inflation protection; 30% in income assets for your expenses and 10% as buffer.