There was a previous post where I had spoken about how to estimate your expenses in retirement? Assuming you have managed to do it at your current prices and then projected it to the first year of retirement, how do you then determine the corpus required for retirement? Well, there are complex calculators available to do this with multiple parameters, but I always prefer a far simpler way for myself and for the people who may seek my advise.
However, before we come to the simple way let us see what many will recommend that you do. It goes like this:-
- Assume inflation rate for your retirement period.
- Divide your corpus into different buckets with different rates of returns.
- Based on these returns calculate the corpus needed for each bucket.
- Add up the corpus derived for all these buckets in order to decide the total corpus.
- Though there are calculators to do this, it is probably far easier to take help from a financial planner.
Why is the calculation of corpus complex? The main issue is that we are dealing with 2 rates namely the Rate of return on the corpus and the inflation in the economy. The difference between these two is the real rate of return. Now the higher the real rate of return, the lower will your corpus need to be. If you have different buckets, each one with a different rate of return the complexity increases more.
The whole issue can be made absurdly simple, however, if we simply take the real rate of return to be zero. In other words you assume your corpus to grow at the same rate as inflation is. Yes, this will mean that you have to look at a slightly higher corpus as compared to a situation where the real rate of return may be 1 or 2 %. However, on the positive side, being this conservative means it is very unlikely you will ever run out of your corpus. With this assumption in place, calculating the retirement corpus required is a piece of cake. You simply multiply the annual expenses in the first year of retirement by the number of years in retirement and you get the corpus. No complex mathematical formulas, no calculators with multiple inputs across tabs in spreadsheets, just something you can pretty much do in your head.
Let me give a sample calculation for my own situation, to illustrate the point.
- Though my annual expenditure today is quite high, I have estimated that 8 lacs per year at current prices is what I will need when I retire.
- My retirement is 8 years away and I have taken inflation to be 7 % in this period.
- In the first year of retirement my annual expenses are likely to be 13.75 lacs.
- Assuming zero real rate of return and a retired life of 25 years, the corpus needed will be 3.43 crores.
- Just for emphasis, this is a very safe figure that will probably let you spend more as time goes by.
This is an example of how personal finance can be made simpler by making certain assumptions that make life simpler and adds safety factor to the calculations. I hope readers will be able to use this to their benefit.
financial safari 
Brilliant. My only suggestion is to give weights to stages in life, say 61-70 = 1, 71-80 = 1.5, >80 = 2 to cater for increasing medication, assisted living, improving longevity, lack of medical insurance beyond certain age. Based on these factors, the corpus of 3.43 Crores gets exhausted in early 80s.
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Yes, I agree. This can be a nice refinement.
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It is assumed here that at the end of the 25th year from retirement there will be no money left. On the other hand one can live on the interest earned from the corpus as well. That way a significant amount of principal corpus will always be available for contingency and as inheritance to the next generation after the person’s death. The person may frame a will to donate the corpus for charity as well. Request your feedback on this.
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Niladri, the plan has been made for 25 years, so the corpus is sufficient for such time. If you want it for longer time then corpus has to increase. As for your other issue, pls understand that initially the interest will be enough to run expenses but as inflation increases the annual expenditure you will start consuming principal amount as well. Hope you get the point.
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Yes, I got your point. However, the interest earned in initial years will be more than required. So a part of that can be reinvested to increase the corpus as well. In short there are means and ways to handle the income through the retirement years. Obviously, you have suggested one of the simplest ways to handle the issue, easily understandable to most. Thanks.
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Niladri in the initial years interest is more but over the years inflation will keep increasing the expenses. For example with 8 % inflation the expenses double every 9 years and with 12 % inflation they will double every 6 years. Do this in a spreadsheet with any starting corpus or use any standard calc available in the internet, which will tell you in how many years your corpus will run out.
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I was thinking of the same and was trying to write it down, but you have articulated it very well – it doesn’t need to be any more complicated! Thank you!
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[…] The retirement corpus is also a function of the real rate of return you are able to get. For those who are unaware of the term, the real rate of return is the difference between your return on investments and inflation. So if your portfolio is giving an overall return of 9 % and the inflation in the economy is 7 %, then your real rate of return is 2 %. In one of my earlier posts, I had shown a simple way to calculate a retirement corpus by assuming the real rate of return as zero. Interested people can read the post here. […]
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[…] now believe that a safer approach is to target a corpus of annual expenses (times) the number of years you expect to live after early retirement. Assuming zero real returns i.e. investment returns compensate for […]
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