Retirement Calculator: How to plan an early retirement
17th December 2020
There is a FIRE movement (financial independence, retire early) which has attracted a lot of attention in recent years. It involves saving through most of your 20s and 30s to gain enough financial independence so you can retire on your terms as early as your 30s or 40s.
This is done by earning more, spending less, saving high (at least 20%), and using the savings to build a retirement fund to live a comfortable lifestyle for early retirement in India.
Tanisha is 25 years old who is planning to retire at the age of 45 and expects to live till 70 years. The inflation rate is considered at 6%, the rate of return for her investments is considered 7%. She is married but has no children and no dependent parents. She also plans to stay in a small town in an independent house after retirement.
To estimate the size of retirement corpus, you need to calculate 3 things:
1. ESTIMATE YOUR EXPENSES
Tanisha is assuming that now she is 45 years of age. In the next few months, she is going to retire from her job. What will be her expenses after retirement? She can create a break-up of her total expenses into following six heads (Not including EMI because it is assumed she will have paid all of it by the time):
Home: Utility bills, maid, fuel, food. etc.
Rs 4.5 lakh per annum
Rs 50, 000 per annum
Health care (It’s higher in old age)
Rs 1 lakh
Rs 1.5 lakh per annum
Any other emergency
Rs 1.5 lakh per annum
Assume Inflation - To be added back to the fund to negate the effect.
Rs 1.5 lakh per annum
TOTAL EXPENSES PER ANNUM
Rs 10.5 lakh per annum
Tanisha would need Rs 10. 5 lakh per annum as income each year. Her retirement corpus has to be big enough to generate this income every year.
2. ADD THE RATE OF INVESTMENT TO BUILD RETIREMENT FUNDS
Based on the calculation from #1 we now know that her annual expenses will be Rs 10.5 lakh per annum, which will be generated from the accumulated corpus retirement funds.
To this, she needs to continue to add 7% per annum rate of investment to keep generating income post retirement. Use this formula to calculate:
|Size of corpus =||Annual income requirement (Rs 10.5 lakh per annum)|
|Investment Yield (7% p.a.)|
This calculation leads to a figure of Rs. 1.5 crore required for our early retirement funds.
3. ADJUST THE INFLATION
The calculated retirement corpus is Rs.1.5 Crore but we need to add inflation rate for each year to this fund to negate the effect.
Tanisha has 20 years before she retires hence her corpus will be much higher, use this formula to calculate: Corpus(n) = Corpus(t) * (1 + 6%) ^n
- Corpus(n) = Corpus after 20 years.
- Corpus(t) = Corpus required today (1.5 Cr).
- n = 20 years.
- 6% = Average inflation in next 20 years.
Corpus(n) = 1.5 * (1+6%) ^(20) = 1.5 * 3.21
Total corpus required =Rs 4.85 cr
Tanisha has 20 years before she retires at age 45 to invest wisely and accumulate the required retirement corpus.
She can invest Rs 20,000 every month to build a decent fund in 20 years.
Your retirement corpus will depend on your lifestyle, your plans and your investments including inflation. You can follow the above steps to get an idea of what you may need. A financial expert can guide you in investment options that meet your requirement.
How much money do you need for retired life?
A retirement corpus is a critical saving that will decide if you will lead a comfortable retired life or not. There is no one-size-fits-all solution but you need to consider the following factors while building your retirement corpus so you don’t fall short in your sunset years.
Post-retirement there will be many limitations and uncertainties, hence it is advisable to start early and save often. Since the corpus needed is quite significant, it may be difficult to save in a short time frame, sooner the better. You may want to consider your retirement goals because retirement saving offers a chance to reduce taxes.
Set a target for your retirement age
It is important to set a target for your retirement age to calculate at what age you would have enough financial stability to live through retirement.
You can be someone eager to retire at 45, but you need to be in good financial health to exit the workforce because retiring at 45 looks very different from retiring at 60. We need to achieve a balance between the size of retirement funds and the length of retirement so your funds can adequately support you.
Prepare for long retirement years
Medical facilities and newer technologies have led to a significant rise in the average longevity of Indians. The longer you live, the more funds you will need for medical complications and assisted living.
Keep an eye on the future
By the time your retirement sets in, some recurring expenses will lower (Children, investments, EMI, etc.) but some costs may go up (Travel, leisure, medical, etc.)
There may be expenses that come up every few months (gifting, celebrations, etc.) and some that come up every few years (Lifestyle, home repairs, etc.)
Risk appetite reduces once earnings cease post retirement, so you may not be able to invest in plans that involve some risk in your later years. The impact of Inflation also plays a major role not only during the accumulation phase but also after retirement. For instance, healthcare inflation may be higher than other consumer inflation estimates.
Think about your spouse’s retirement
Studies show that females on average lives longer than males. A man at 60 may live for another 15 years, whereas a female will live for another 19 at the same age. If there is an age gap between the spouses, it will add up to the time when the surviving spouse will have to live alone and would be solely dependent financially on the retirement corpus.
The right corpus
- Don’t get lured with lucrative schemes that are too good to be true
- Stay off debts. Invest within your boundaries and regularly
- Monthly expenses and income are critical to factors in your retirement corpus
- Whether you are an aggressive or a conservative investor will also determine your contribution to the retirement corpus
How to save for early retirement
If retiring early is your goal, here are six steps you should take to save for early retirement.
Change your attitude about money
There is a difference between ‘living rich’ and ‘being rich’. Living rich is when you earn Rs 5 lakh every month and spend all of it but being rich is earning Rs 5 lakh every month but spending Rs 2 lakh, investing Rs 1 lakh and having Rs 2 lakh in the bank. The key is to focus on your spending, not your earnings.
Adjust your current budget
Reconsider your utilities and level down your expenses to a bare minimum on transportation, food, utilities and housing costs (Use public transport, lesser domestic help, frugal food habits, etc.). Many people with early retirement ambitions funnel a major part of their income into savings and aim to live on less than 50% of their income. Avoid debts but a home loan could help save tax and is a key to cutting down expenses.
Look for ways to bring in extra income or return on your current investments that can go directly into your early retirement corpus.
Calculate your annual spending post-retirement
On retirement, a lot of your expenses are cut down but if you are already in the habit of living off a small portion of income, you may continue to do so for retirement. You can put together a retirement spending estimate based on your current spending habits.
Your retirement goals will determine which expenses will go up, if you have factored in a new house or extensive travel. We recommend keeping some room for inflation and increase it by 10-20%.
Do not overlook taxes and healthcare.
A financial advisor can help you develop a strategy to tap investments while saving on taxes from an early age.
Estimate your total savings
Follow the rule that you should have 25 times your planned annual spending saved. If you plan to spend Rs 10 lakh in the first year of retirement then you need to have Rs 2.5 crore invested when you quit working. However, you need to adjust the withdrawal strategy to keep up with the inflation every year during the retirement years.
Your approach should depend on your investments, risk tolerance and market performance.
Keep expenses in check
Planning your retirement corpus is hard but it's even harder to stick to it including making financial decisions outside your comfort zone. Your expenses need to be in line and supportive of your financial goals because your corpus may not be able to withstand large withdrawals and this increases your likelihood of running out of money.
Invest for long term growth
Retiring early means you have a shorter period for saving and a longer period where the money you’ve saved needs to support your spending. You will need the best investment returns from a balanced portfolio geared towards long-term growth.
Early retirement is achievable if you work diligently towards it by altering your attitude, saving and controlling your spending habits.
Why is retirement planning important?
Most of our dreams for our years after retirement require us to plan ahead, and we have to be financially prepared for it.
Our life expectancy has improved over the years due to advancements in technology and medical sciences. In India, the average life expectancy has increased now to 70 years, while the retirement age has stayed constant at 58-60. Many Indians live for an average of 15 to 20 years after retirement from active professions.
Increasing cost of healthcare
Healthcare costs are rising every year in India at an alarming rate. You may have an updated health insurance policy but these do not cover 100% costs, hence managing expenses related to your health can be really challenging.
You need to plan healthy finances for your retirement because you cannot work forever. Also, it's important to be responsible and plan well ahead in good times so that you are not dependent on your children or anyone else in your retirement days.
You put your nose to the grind during your working years, running around and getting things done and also fulfilling your responsibilities to your ageing parents or growing children. Hence, retirement is your time to fulfil your wishes whether its travel, contributing to a social cause or devouring a must-read book.
We should never question the ability of our family to have done well enough or consider being dependent on their savings. Also, you never know or be certain about what you may inherit, when and how much, and if you will really end up getting anything.
Contribute and make your family happy
Imagine when you retire being surrounded with children and grandchildren and being able to gift them something they always wanted, being able to travel across the country or maybe across the globe whenever you have to meet your family, or the freedom to book your own tickets without having to think much, for festive get-togethers. These are the little joys of life we will need in our sunset days.
The future is uncertain
We are conditioned to believe that we need to be more optimistic that our future will always be better. There is no guarantee that the speed bumps you faced in the past or present that required financial intervention may not come up again in the future, especially post retirement.
If you did not give more than a passing thought to planning your retirement, then it's now that you need to think about your retirement years and plan today for the money required to fund that life.
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