PFRDA

Methods of Determining the Income requirement in Retirement

Before getting on with the discussion of what Retirement Corpus is required, it is very important that one understands- what may/would be ones requirements which one would need to provide for during the retirement?

For this, it is important to understand that the various expenses heads (refer Budgeting & its Importance) do not remain constant and change over the job life and also post job life (during the retirement phase). Some of the heads which may see a drastic upward/ downward shift is as follows-

Transportation- generally sees a downward trend since travel for work is reduced
Healthcare expenses- sees a very drastic upward shift post retirement
Discretionary expenses (entertainment & holiday) – a bit of upward trend as retirees have a lot of time to spend.
Housing- if one doesn’t own a house and relies on rented accommodation, this cost weighs heavily on the same
Tax outgo- may see a little bit of fall
Education- under ideal conditions, this should not be there post retirement
Loans- under ideal conditions, all debts should be closed/ paid off.
Investments for retirement- typically the investments being made for retirement would either cease and/ or reduce.

Having a clear understanding of how the different expense heads work and their importance post retirement is very important while deciding on the income one would require post retirement. Following are the two methods using which a basic idea of income requirement post retirement may be gauged.

Note- However, to get a better idea about the methods it is advisable that one prepares a Personal Budget Statement. Not only does it give an idea of a person’s present financial position, his spending and saving patterns but also a glimpse of what he/she may require after retirement to lead the same standard of life.

Income Replacement Method

The income replacement ratio is the percentage of the income just before retirement that will be required by an individual to maintain the desired standard of living in retirement. Usually 70 percent to 90 percent of the income before retirement is required to maintain the lifestyle of the individual after retirement. The income replacement method is simple to follow and useful to set a target for savings when retirement is some time away. But like all rules of thumb it does not take individual circumstances into consideration. Assuming that expenses in retirement will automatically go down may be erroneous and too simplistic

Income replacement ratio =

Gross income post retirement/Gross income pre-retirement

Number crunching to understand the Income Replacement Method

Person X is 30 years old and has current gross annual income of Rs.6,00,000/-; her annual increment is approx. 10%. She wants to retire at 60. She wants to know what her income requirement at retirement be. Assume Income Replacement ratio at 75%, 80% and 90%.

Current Annual Income	600,000
Present Age	30
Age of Retirement	60
Time to Retirement	30
Annual salary increment rate	10%
Annual Income at Time of Retirement	10,469,641
Income Replacement Ratio(s)	75%	80%	90%
Annual Replacement Income required	7,852,231	8,375,713	9,422,677

It may be observed from the above table that more conservative we are in our approach towards the replacement income (i.e. higher is the replacement income %), the more income we or the retirement planner would be required to meet it. Hence, with a liberal replacement ratio of 75%, the planner would need Rs.78.52 Lakh per annum to replace and live her pre-retirement lifestyle and with a more conservative approach of 80-90% replacement, it further increases to Rs.83.76 Lakh and Rs.9423 Lakh, respectively.

Expense Protection Method

As the name suggests, this method looks at retirement income from the side of expenses i.e. the focus is on identifying and estimating the expenses likely to be incurred in the retirement years and providing for it.

Number crunching to understand the Expense Protection Method

Expense Protection is a slightly cumbersome method due to the detailed listing out of expenses incurred for the things/services required post-retirement. Also, the use of the Personal Budget Statement may arise when we are trying to estimate retirement income through this method.

Person X is 30 years old and has current monthly expense of Rs.30,000/-; out of which approx.. Rs.17,500/- is for essential household expense and Rs.2,500/- as discretionary expense, which she expects would continue post-retirement as well. She wants to retire at 60. She wants to know what would be the Expected monthly expense considering that in her retirement considering that expenses would be growing at a rate of 7% (inflation rate).

Total Expenses (Rs.)	30,000
Monthly Household expenses (Rs.)	17,500
Monthly household expense as % of total expense	58%
Additional discretionary expense in retirement (Rs.)	2,500
Total Expenses (relevant in Retirement Household expenses+ Additional discretionary expense)	20,000
Present Age	30
Age of Retirement	60
Time to Retirement (years)	30
Expected rate of Inflation	7%
Expected monthly Expense (Rs.)	152,245

It may be observed from the above table for a monthly expense of Rs.20,000/-, in 30 years the expected monthly expense after 30 years (considering present age as 30 years and retirement age as 60 years), would be approx.. Rs.1.52 Lakh per month! If the inflation rate, increases and is at 10%, the monthly expense would be approx. Rs.3.5 Lakh per month!

Note- Estimating this expense amount wrongly may make the determination of retirement corpus inaccurate. The process involves preparing a list of pre and post-retirement expenses, and arriving at the total expense list. The expense so calculated has to be adjusted for inflation over the period of time left to retirement to arrive at the expense in retirement. If expenses are overlooked or underestimated there is a risk of overspending in retirement since the income required would be calculated lower.