Financial experts recommend that people should begin planning for retirement savings from the first day of their first job. Most individuals however regard saving for retirement as being unnecessary and such people often end up running short of money during their old age.
In addition to a late start, which typically leads to an inadequate retirement corpus, there are other errors that people make when calculating their retirement corpus.
Presented below are 6 of these major calculation mistakes and the respective corrective measures that need to be taken.
It is assumed that your current age is 30 years; you will retire at 60 years of age; your expected life span will be 80 years; the expected rate of savings growth will be 12 percent; expected medical inflation will be 10 percent; and expected rate of inflation will be 6 percent.
- People do not take into account the inflation rate when saving for retirement
Individuals who do not consider inflation when fixing the corpus for retirement will find that the eventual corpus saved does not last for very long post retirement.
- If you are currently earning INR 50,000 per month and spend INR 35,000 every month, then the corpus amassed by you at the time of retirement without accounting for any inflation will be INR 54 lakhs. If you take 6 percent inflation into account, then the present value of corpus will be INR 14.6 Lakhs
- People underestimate post retirement expenses
Most of us think that our expenses will drop after we retire. This may however not be true for everyone. There may be a reduction in debt repayment and children’s expenses, but there may be a concurrent high rise in travel and medical expenses. Thus, any assumption about post retirement savings being on the lower side may result in an inadequate corpus.
- If you estimated your monthly expenses after retirement to be around INR 86,150, then such incorrect estimates will result in a corpus of just INR 2.64 crores. However, if you correctly estimate your monthly expenses after retirement to be around INR 2.01 lakhs, then the corpus amassed will be INR 5.76 crores.
- Excessive withdrawals from corpus
A safe and good rate of withdrawal from the corpus is the approximate sum that you may spend each year without draining the corpus during your lifetime. Financial experts recommend withdrawal of around 3 to 4 percent each year. Most of us however see a sudden and unexpected rise in our expenses just after retirement and this can result in rapid draining of corpus funds.
- If you have a corpus of INR 5.76 crores, then a withdrawal rate of 8 percent per year will be marked by monthly withdrawal of INR 3.84 lakhs and yearly withdrawal of INR 46.08 lakhs. This means that the retirement corpus will last for only about 12.5 years.
- For INR 5.76 crores corpus, a withdrawal rate of 6 percent per year will be marked by monthly withdrawal of INR 2.88 lakhs and yearly withdrawal of INR 34.56 lakhs. This means that the retirement corpus will last for about 16.6 years.
- For INR 5.76 crores corpus, a withdrawal rate of 4 percent per year will be marked by monthly withdrawal of INR 1.92 lakhs and yearly withdrawal of INR 23.04 lakhs. This means that the retirement corpus will last for about 25 years and thus sufficient to take care of your expenses till you are 85 years old.
- Saving for an inadequate number of years
If you do not begin saving for retirement at an early age, then you may have an insufficient corpus even when you raise the amount saved every month as you near the age of retirement.
- If you begin saving for retirement at age 40 years with an investment of INR 15,000 per month and a 12 percent rate of return, then the corpus amassed at retirement will be INR 69.7 lakhs. If you increase the monthly investment to INR 35,000, then the corpus amassed after 20 years will be INR 1.6 crores.
- On the other hand, if you begin saving for retirement at age 25 years with an investment of INR 15,000 per month and a 12 percent rate of return, then the corpus amassed at retirement will be INR 2.1 crores.
- Investments just in debt instruments
As one approaches retirement age, it is advisable to reduce the equity part of your investments so as to safeguard the corpus and decrease the associated risk. It may however be noted that some part of the investments should continue to be made of equity as it is needed for capital growth during the retirement years.
- If you invest all your monies just in debt, then the INR 5.76 crores corpus will appreciate at the rate of 8 percent. This means that after 20 years, it will grow to INR 26.84 crores.
- On the other hand, if you invest 65 percent in debt and rest 35 percent in equity, then INR 3.74 crores of the INR 5.76 crores corpus will appreciate at the rate of 8 percent, while INR 2.01 crores will grow at 12 percent. This means that after 20 years, it will grow to INR 36.89 crores.
- SWP taxation in debt funds vs. Fixed Deposits
One of the most common mistakes that we commit is not taking into account the returns after tax when selecting between different options of investment like post office MIPs, Senior Citizens’ Savings Scheme, or FDs. Tax will be levied on the interest gained on such investments. Hence, a better choice is systematic withdrawal plan or SWP in debt linked mutual funds. The long term capital gain of these funds is charged at 20 percent post indexation, thereby substantially slashing the total tax applicable.
- An investment of INR 10 lakhs in fixed deposit will earn an interest rate of 8 percent per year, which results in earnings of INR 80,000 before tax. This interest earning will be taxed at 30.9 percent, i.e., INR 24,720 will be deducted as tax and the total earnings from FD post tax will be INR 55,280.
- On the other hand, an investment of INR 10 lakhs in SWP with annual SWP amount of INR 1.2 lakhs will earn an interest rate of 8 percent per year. In the 4th year, the long term capital gain will be INR 28,896 and the 20 percent tax levied with indexation will amount to a mere INR 2,299. Thus, the annual income earned after tax will be INR 1.17 lakhs.