Make Your Sunset Years Cash Positive

There are several layers to retirement planning—estimating future expenses, duration of retirement, level of current savings that need to grow so that they suffice for our sunset years. To understand the nuances of such decisions, let us discuss an illustration that shows how to plan for retirement, and the cash flows post retirement.

Let’s say, 48-year-old Amit Patel expects to retire at 60, and has 12 more working years. He estimates his monthly expenses to be Rs 40,000 at present. His life expectancy is 80 years, which means he has to plan for 20 years when he will not have any active income.

Know Your Numbers

Inflation Adjustment: To start with, we need to see how much Patel would need as monthly expenses after 12 years, when he retires. The estimate of Rs 40,000 per month is as per the current needs and price levels. So how much would the monthly expenses expand to after 12 years?  

To reach that amount, we will need to factor in inflation. Let’s assume the annual inflation rate is 5 per cent. If you compound the amount for 12 years at an annual inflation rate of 5 per cent, Rs 40,000 will become Rs 71,834. For ease of calculation, let us assume this to be Rs 75,000 per month. This is the amount required per month post retirement

Future Returns: The next step is to assume a rate of return on the corpus post retirement because even as Patel withdraws funds, the remaining amount will continue to earn returns. Again, it is difficult to take a call on future returns, but let us assume 8 per cent since the risk profile of investments at that time would likely be conservative. Our assumption of inflation is 5 per cent. Back-of-the-envelope calculation shows that from age 60 to age 80, the net return will be 8 per cent (rate of return) minus 5 per cent (rate of inflation), which is 3 per cent. However, the real returns, net of inflation, will reduce further to 2.86 per cent. You can use an Excel formula or online inflation calculator to see the results for different rates of inflation and returns.

Now, we arrive at the first critical calculation: how much money Patel will need in his retirement kitty at age 60? The requirement is: Rs 75,000 per month or Rs 9 lakh per year, for 20 years, at a net rate of 2.86 per cent every year. The amount required at the end of 20 years would be Rs 1,39,52,646. Let’s round it off to Rs 1.4 crore. Again, you can use the formula for present value (PV) in an Excel sheet or use an online calculator. [If you are using an Excel sheet, the variables will be NPER or the number of payment periods (20 years), PMT or payment per term (Rs 9 lakh), rate per year (2.86 per cent) and FV or future value (assumed to be nil as Patel would consume the entire kitty till 80 years)].

Building A Kitty: Now let’s see how Patel will build a kitty of Rs 1.4 crore in 12 years using systematic investment plans (SIPs) from mutual funds. He should do an SIP in a blended portfolio of equity, debt and gold. He is nearing the consolidation phase of life, and the ratio of allocation to the asset categories should be as per his risk profile.

But how much should the SIP amount be? Let us assume that in the blended portfolio, he gets a return of 8.2 per cent every year. The SIP amount required would be Rs 57,026 per month. [For finding out the SIP quantum per month, use the PMT function in Excel. The variables are rate (8.2 per cent / 12 or 0.683 per cent per month), NPER (144 as it is taken monthly), PV (to be calculated), FV of Rs 1.4 crore (the targeted corpus) and Type 1].

In the above example, PV is nil. However, since Patel is a working professional and probably has some savings such as Provident Fund or mutual fund investments, his SIP requirement will be reduced to that extent. Let’s assume that he has an existing corpus of Rs 30 lakh, including bank deposits, Provident Fund and mutual funds. In such a case, the revised requirement of SIP investment would be Rs 24,446 since the existing corpus will also keep earning 8.2 per cent every year for the next 12 years.

Post-Retirement Cash Flow

Once the corpus of Rs 1.4 crore is built, for the next 20 years, you can put the money in appropriate mutual fund schemes and structure a systematic withdrawal plan (SWP). In SWP, you have the flexibility of withdrawing in part or as lump sum, if and when required. However, Patel will be looking at `75,000 per month or `9 lakh per year. Assuming a net return of 2.86 per cent every year, the cash flow will last for 20 years (see Managing Post Retirement Cash Flow).

This is just an illustrative case. Taking a cue, you can estimate your variables and build your own calculations that will give you a perspective, net of inflation, of how much your expenses are going to be, and how much you need to save.

The author is a Corporate Trainer, Author and Columnist