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Retirement Planning: How much annuity would I need in 20 years when I am 60

Jun 22, 2016 by Advisorkhoj Research Team | 59 Downloaded
Picture courtesy - PICJUMBO

Last week I was at a retirement party thrown by my friend’s uncle, when one of the placards hung from the ceiling caught my eye. It read:

I’m retired! Goodbye Tension!! Hello Pension!!!

While the placard made me laugh at once, on second thoughts I reflected on the same. Yes, retirement can be a cause of celebration and hence a party if one has planned for continued pensions in their retirement. But what if one hasn’t?

Retirement means withdrawing from active employment or leaving work. It also means letting go of the source of income and as such while some celebrate retirement, others dread the phase considering it impossible to meet the underlying expenses. Whether retirement gives you the jitters or puts a smile on your face is entirely up to your financial planning and the portfolio you built. If you included retirement planning early in your portfolio, you are blessed to lead a comfortable retired life. On the contrary, if you delayed formulating a sound retirement corpus, or did not create any retirement corpus, you are cursed to live your retired years in financial stress.

Retirement planning is an essential tool if you want to retire comfortably without any financial constraints. One of the questions which plague individuals wanting to build up a retirement corpus is the complexity of numbers and calculations. People do not understand how much is the amount they would require after they retire. And so, the question, how much annuity would be when they retire?

This Retirement Planning Calculator might help!

Various websites and financial service providers have developed a retirement calculator which calculates the amount of annuity required after retirement after taking into consideration your present financial standing, income, expenses, years to retirement, inflation, etc. However, for laymen, which most of us are, it is important to understand how the calculators work or how the retirement corpus is determined which in turn provides annuities. So, here is a lowdown on computing how much annuity is required after one retires.

Before we start, first, let us understand what annuity is. The Oxford Dictionary defines annuity as, ‘a fixed sum of money paid to someone each year, typically for the rest of their life.’ So, the regular stream of income which we receive after retirement, which most of us call pension in common parlance, is nothing but annuity.

Now, when we have understood what is annuity, let us see how to compute the amount of annuity required after retirement.

  • Estimated annual expenses

    – the first step in this computation is ascertaining what your average expenditure in one year is taking into consideration all types of expenses generally incurred. These can be rent, children’s tuition and school fee, household expenses, conveyance expenses, entertainment related expenses or expenses incurred on taking a family vacation.

    This annual outlay is important as your expenses after retirement would be based on your present day expenses. For example, Mr. Arvind aged 40 has the following list of expenses incurred monthly:


    Expenses Incurred Monthly


    (We have taken the example of Mr. Arvind who is aged 40 presuming he is starting his retirement planning late)

    Annual expenses – (Rs.65, 000*12) = Rs.7.8 lakhs

    If we assume a yearly vacation expenditure of Rs.1.2 Lakhs, then the estimated annual expenditure comes to Rs.9.00 lakhs. As per expert financial advisors, you should make sufficient provisions to meet 80% to 90% of your current annual expenditure at retirement. Though children’s fee, house rent (assuming you move into your own home) and other expenses would be reduced when you are old, the medical expenses would increase. Thus, expecting an expenditure which is 80-90% of the current level is safer.

  • Factoring in inflation

    – if we are calculating a corpus required after a gap of a long duration, inflation has to be factored in because the real value of money depreciates over time due to inflation. So, the annual expenses calculated above have to be adjusted with inflation to arrive at the expected expenses post retirement. To estimate the rate of inflation, we need to see the past trends. The following graph shows the rate on inflation over the last few years:


    Expenses Incurred Monthly


    Though the rate has come down in the last two years, it is better to assume a conservative rate of 6% for our computations. Since we want to arrive at the annuity requirement after 20 years, the expected value of our expenditure when we retire would be:

    Expected annual expense – Rs.9 lakhs * 80% = Rs.7.2 lakhs

    Expected Monthly expense – Rs.7.2 lakhs /12 = Rs.60, 000

    Inflation rate expected – 6% per annum

    Period – 20 years

    Expected inflation adjusted monthly expenses after 20 years = 60,000*(1.06) ^ 20 = Rs.192, 428.

    Expected inflation adjusted annual expenditure after 20 years = Rs.2,309,136 or Rs.23.00 Lakhs approximately.

So, the above calculations show the amount of annuity required after 20 years when you retire. If the numbers are any indication, you would need a whopping Rs.23 lakhs in annuity payments at 60 to lead a comfortable retired life. And what would be the corpus amount which would generate such a high annuity - Rs.1 crore, Rs.2 crore or Rs.5 crores?

Well, don’t get confused. If there is a formula to calculate the amount of annuity needed, there is also a formula to arrive at the corpus required to generate this annuity. For this computation, we need a conservative rate of return. If we consider the current rates on fixed deposits, which are risk-free, a 7% return can be considered. Now, we need a corpus which, through its 7% annual return yields Rs.23 lakhs. Following the unitary method of simple mathematics,

If 7% = Rs.23 lakhs,

100% = (23 lakhs/7) * 100 = Rs. 32,857,143 or a corpus of Rs.3.28 crores approximately.

The amount of corpus required in retirement must be making your eyes bulge out and with 20 years remaining to retirement, have you chalked out a plan yet?

Retirement planning, as touted by experts and as is evident from the above figure, should be resorted to at the earliest. With 20 years in your hands, it would be difficult to arrive at the said figure without a considerable saving. So after you arrive at the amount of annuity required at the age of 60, you should take the next step which involves allocating your investments to a retirement corpus which would yield the computed annuity. Since we are not millionaires with unlimited funds at our disposal, a regular and a disciplined saving habit would have to be inculcated and you would have to allot a specified amount of money every month towards building this corpus.

When it comes to the question of allotting money, there are two obvious factors to consider – the savings which can be comfortably invested by you and the rate of return expected. So let us understand the importance of each of these factors:

  • The possible amount of saving

    – though we arrived at a huge figure of retirement corpus required in our calculations (Rs.3.82 crores), it is ultimately our savings which need to be allotted for creating the corpus. Since our income is limited and expenses unlimited, we have to first arrive at the amount of money which can be saved by us every month. The amount computed should be practical and possible to be invested every month for a disciplined savings approach.

  • The return expected

    – now this is a tricky one. There is no uniform rate of return which can be expected out of your savings. Every investment avenue has a different risk profile and hence provides a different rate of return. The common rates of returns of some popular investment options are as follows:

    The return expected

The expected rate of return would determine the size of your retirement corpus and you would have to choose the investment which suits your risk appetite. From the above example you can see that returns from equity mutual funds are the highest in the long term. You can check how equity mutual funds have performed over 5, 10 years period. Therefore, if you saving a good part of your corpus in equity mutual funds then by investing even a smaller amount you can have a bigger corpus.

In fact if you compare returns of debt mutual funds, they are superior to bank fixed deposits. Therefore, by investing in debt funds instead of bank fixed deposits you can earn 2 – 4 per cent more. Debt funds are also tax efficient and there are no TDS (Tax deduction at source). If you compare debt funds with fixed deposits you will know the difference between the two.

The ideal way to decide in which asset class to invest and how much, you should check your risk profile and diversify your investments where you allocate a specific proportion of your savings to different asset classes to earn the best possible return with the lowest possible risk exposure. Diversification also helps in hedging against the exposed risk and is recommended. Please try this asset allocation calculator

Let us also look how your final corpus may look like at different rate of returns on investment of 100,000 lumpsum -


How your final corpus may look like at different rate of returns on investment of Rs. 100,000 lumpsum


From the above chart you can see how a difference of couple of per cent return can change the final maturity amount. Therefore, it is advisable to spread your investments in different investment buckets to reach your final retirement corpus without much difficulty. Learn how you can invest small amounts systematically to reach your retirement corpus

Conclusion

Hope you now know how much annuity you will need in 20 years and how to allot your funds in a balanced and diverse manner to achieve the desired corpus when you reach 60 years of age. My friend’s uncle must have solved his retirement corpus equation well in advance and he would have also planned his corpus. Knowing he was going to have a comfortable retirement must have prompted the party and the message on the placard. He was going to enjoy his retirement, what about you?

You may also like to read –

Is mutual fund retirement plans suitable for you

How to plan retirement through mutual funds

Mutual Fund Investments are subject to market risk, read all scheme related documents carefully.

Locate DSP Blackrock Mutual Fund Advisors in your city

Advisorkhoj Research Team

Our research team has a combined experience of nearly 40 years in the financial services management and distribution, across the entire spectrum of product classes including mutual funds, insurance, equity broking and loan products. To contact our research leads, please see their contact information below.

Dwaipayan Bose: dwaipayan@advisorkhoj.com
Pradip Chakrabarty: pradip@advisorkhoj.com

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