**Retirement Planning… A Quick Guide for the Amateur…**

Dear Reader,

This blog post is aimed at helping my readers understand the key steps, assumptions and calculations involved in Retirement Planning, using the fundamentals of Time Value of Money.

The significance of Retirement Planning in an Individual’s Life is paramount and remains undisputed. However because it also happens to be one of the farthest goals of our lives, there is a tendency to delay planning for it in the early years. One must realize though, that the more it gets delayed, the more challenging it becomes to achieve this goal.

Here is a case to help you understand how one can go about planning one’s Retirement starting at a young age.

*Case:** A young married salaried
professional, aged 35, sole earning member of the family, aiming to retire at
60, is planning for retirement in consultation with his spouse (a homemaker). *

*Note:** With a few key assumptions
in consideration, we throw light on the basic Retirement Planning Process. The
assumptions made here are specific to this case and could change from
individual to individual with varying circumstances. Hence relevant adjustments
need to be made wherever required.*

**Given below are some the important steps involved:**

**1. **__Estimating the Present
Monthly Expenses:__

The couple should begin by asking themselves a hypothetical
question: **If the working member of the
family were to retire today, how much money would the family need every month
to take-care of their expenses?** (Family in this case refers to the Retiree
& His Spouse. Let us assume that the spouse is of the same age too.)

Note: A couple’s post retirement expenses would largely comprise basic living expenses, travel & health expenses and a few other miscellaneous spends. Although children’s expenses and EMIs aren’t likely to be a part of the post retirement expenditure, the allocation towards travel and healthcare is generally seen to be on the higher side during this period. Most retirees prefer to spend more on leisure and travel in their early retirement years; which explains the higher allocation towards these heads. Moreover, the cost incurred on healthcare (insurance, doctor consultations, hospitalization, medicines, etc.) is also expected be much higher in these years. A couple planning for their retirement should necessarily account for these key aspects in their overall estimates.

**So let’s assume that this
couple arrives at a Monthly Expense Figure they believe is reasonable if the
earning member were to retire today…Here is what they came up with…**

**Estimated Present Monthly
Expenses: Rs.50,000/-
**

**2. **** Deciding on the Age of Retirement: **Assumed to be 60 years in this case

__ __

**3. **** Calculating the Approximate
time left for Retirement:** 25 Years in this case,
as the couple in consideration are both presently aged 35 and the working
member expects to retire at 60.

** **

**4. **** Accounting for the Rising
Cost of Living (Inflation):** 5% p.a. assumed in
this case

Since the actual retirement will be due about 25 years from now, it is important to account for the potential impact of inflation on the family’s monthly expenses during the pre-retirement period as well as the post-retirement period. We assume this figure to be 5% (average) throughout the couple’s life span (Pre and Post-Retirement Period).

**5.
****Estimating Monthly Expenses Expected at the time of Retirement
(i.e.25 years from now):**

Using a suitable inflation figure (Assumed to be 5% p.a. during this period), one can extrapolate today’s monthly expenses to the approximate monthly expenses at the time of retirement.

Here’s how we do it in Excel:

**Future Value = Present Value * (1+R)**

^{^N}**Future Value =** Monthly Expenses expected at the time of Retirement

**Present Value =** Present Monthly Expenses (Assuming one were to retire today)

**R** = Rate of Inflation (assumed to be 5% p.a)

**N** = Approximate time left for retirement (25 Years in this Case)

Applying the above formula:** **

**Monthly Expenses Expected at the time of Retirement = Rs.**

**1,69,318/-**

*This figure
implies that the Monthly Expenses which is presently at Rs.50,000/- inflates to
Rs,1,69,318/- per month at the time of retirement i.e. @ 60. It is important to
note that the standard of living remains the same despite this escalation. This
is due to the impact of the rising cost of living on the family expenses in the
25 year period. *

* *

**6. **** Deciding on a Suitable Life
Expectancy:** Assumed to be 85 Years in this case.

Life Expectancy is an important consideration for retirement planning computations since it allows us to determine the total life span to be covered under the plan. Thus, we begin by attaching a suitable Life Expectancy Figure to the individuals in consideration. Let’s say the average life expectancy of a healthy individual enjoying a fairly decent standard of living and with access to good health care facilities is around 85 Years. So in this case let’s assume that the couple decide to go with a life expectancy of 85. It is advisable to consider a slightly optimistic Life Expectancy and try to target a bigger retirement corpus so that the risk of longevity is taken care of. This will ensure that the couple doesn’t outlive their corpus.

**7. **** Calculating the Post
Retirement Life Span: **25
Years in this case.

The Post Retirement Life Span represents the number of years the corpus should last after retirement, if the family makes periodic withdrawals from it to manage their living expenses. This figure should be arrived at on the basis of the life expectancy of the individuals in consideration and the retirement age of the Key / Sole Earning Member. So in this case, since the retirement age of the earning member is 60 and the Life expectancy of both the individuals is 85, the post retirement Life span to be covered will be 25 Years (85-60). In cases where there is a difference in the ages of the concerned individuals, the Post Retirement Period should be based on the expected life span of the younger individual from the date of retirement of the key earning member. In short the Life Span considered should be good enough to cover the younger member’s life too.

** **

**8. **** Deciding on the Expected
Returns Post Retirement: **Assumed to be 7% in this case.

The corpus accumulated at the time of retirement needs to be deployed in appropriate investment avenues considering a balance of both safety and inflation beating returns. In this case we assume the annual returns during the post-retirement period to be around 7% for all our computations.

** **

**9. **__Calculation of Real
Returns during the Post-Retirement Period:__

The Real Returns on any investment is the effective returns earned after accounting for inflation. Real Returns can be calculated using the formula:

**Real Returns = (1+R)/(1+I) - 1**

Where, **R = Returns (R) p.a.
expected from the Instrument**

**I = Inflation (I) p.a. (Rise in Cost of Living) **

Thus, for an expected annual return of 7% p.a. and an inflation rate
of 5% p.a., the Real Returns generated on such an instrument would be
approximately 1.9% p.a. *For computation
purposes, this figure will have to be adjusted to a suitable Annual Percentage
Rate - APR, taking into account the number of compounding periods per year (in
this case, the number of withdrawals per year). *

Thus, **Approx. Real Returns Per Year =** Rs.1.89% (A.P.R. with 12
compounding periods)

**Approx.
Real Returns per withdrawal period: 1.89% / 12 =** 0.157% p.m.

Conversion to APR can be done using the NOMINAL Function in Excel:

**NOMINAL(effect_rate,npery)**

Where, **effect_rate =**
Annual Percentage Yield (1.9%)

**npery
=** Number of Compounding Periods / Withdrawals per year (12)

** **

**10.
****Computing the Target Retirement Corpus to be accumulated at 60:**

Based on the inputs gathered, one can easily compute the target retirement corpus using the Present Value Function in Excel.

**Excel function for Present Value **

**= PV(rate, nper, pmt, [fv], [type])**

The following inputs are needed for this calculation:

** (rate) Real Returns per withdrawal period: 1.89% / 12 = 0.157% p.m.
(approx.**)

__(nper)__ Total number of withdrawals in the 25 year period: 25*12 = 300

Total Life Span (Period) to be covered post retirement: 25 years

No of withdrawals per year:12

** **

__(pmt)__ Estimated Monthly Expenses at the time of Retirement (First
Withdrawal) = Rs.1,69,318/-

This amount is the first monthly withdrawal at Retirement. The amount will continue to rise as the cost of living increases.

** **

__(fv)__ Future Value i.e. Corpus Left at the end of the 25 year period =
Zero…

Having a surplus corpus at the end of the period is certainly a desirable outcome. But

for now, let us assume that the entire corpus is consumed by the end of the stated period.

__ __

__(type)__ = 1

In the PV function of excel, type can be either 1 or 0 depending on whether the cash flow

takes place at the beginning of the period (1) or at the end of the period (0). In this case we assume that withdrawals happen at the beginning of every month, and hence we take this value to be “1”.

__(pv)__ Present Value i.e. the corpus required at the time of retirement:
To be calculated using the above values in the PV formula

**= PV(rate, nper, pmt, [fv], [type])**

**Thus Corpus required at the time of retirement =**

**Rs.4,05,27,816/-**

To achieve the target corpus, one has to make periodic investments in appropriate instruments starting today. Let us estimate how much one needs to invest every month to meet this goal.

**11. **** Deciding on the Expected
Returns in the Pre-Retirement phase: **Assumed to be 11% in this case.

Since the pre-retirement phase in this
case is about 25 years, given the long time frame available, it is important to
ensure that the savings are deployed in highly efficient instruments such as
equity. In this case let us assume a return of 11% p.a. *For computation purposes, this figure will have to be adjusted to a
suitable Annual Percentage Rate - APR, taking into account the number of
compounding periods per year ( in this case, the number of contributions per
year).*

**Thus, Expected Returns Per
Year = **Rs.10.48% (A.P.R. with 12 compounding
periods)…

** Expected Returns
per contribution period= 10.48% p.a. /12 = **0.87%
p.m.

Conversion to APR can be done using the NOMINAL Function in Excel:

**NOMINAL(effect_rate,npery)**

Where, **effect_rate =**
Annual Percentage Yield (11%)

**npery =** Number of Compounding Periods / Contributions per year (12)

Kindly note that one has to be prudent in their assumptions as far as expected returns are concerned and avoid overestimation.

**12. **__Calculating the Monthly
Savings to be set aside / invested to achieve the Target Corpus:__

The **“PMT”** Function in
excel can be used to arrive at the Monthly Investment required to reach the
targeted retirement corpus.

The following excel function can be used:

**= PMT(rate, nper, pv, [fv], [type])**

The inputs needed for this calculation are:

__(rate)__ Expected Returns per contribution period: 10.48% p.a. /12 = 0.87%
p.m. (approx.)

__(nper)__ Total number of monthly contributions in the 25 year period: 25*12
= 300

Total Pre-Retirement Period: 25 years

No of contributions per year:12

** (pv) Present Value (Savings in Hand): **We
have assumed it to be zero in this case.

We assume that the young couple is starting afresh. Hence Zero Savings in hand.

** **

__(fv)__ Future Value i.e. the targeted retirement corpus = Rs.**4,05,27,816/-**

** **

__(type)__= 1

Note: In the PMT function of excel, type can be either 1 or 0 depending on whether the cash flow

takes place at the beginning of the period (1) or at the end of the period (0). In this case we assume that contributions happen at the beginning of every month, and hence we take this value to be “1”.

__(PMT)__ The Monthly Savings to be invested every month can be calculated
using the following excel function

**= PMT(rate, nper, pv, [fv], [type])**

**The Monthly Investment required to meet the targeted Retirement Corpus: Rs.27,884/-**

**Conclusion:** To get a fair
assessment of your Retirement Needs, it is important to ask the right questions
vis-à-vis your expectations out of a Retired Life. For instance, questions like
**“Would you wish to maintain the same
standard of living or a better one or Would you settle for a very austere,
conservative way of life?”** are crucial. The expected standard of living
affects other factors in your computation and eventually determines the monthly
savings you would need to reach your retirement goal. A fair understanding of
the Time Value of Money which is nothing more than basic school arithmetic, a
little bit of Excel, and a basic understanding of the factors involved in
planning as discussed above will go a long way in helping you design a
customized plan for your needs…

**You will have more such insights coming your way in
the times to come… Till then… Stay Tuned… **

__About the author__

**CERTIFIED FINANCIAL PLANNER**

^{CM}, Dip TD, MMS.**CFP**and has been working in the financial services domain for close to 13 years. He holds a

^{CM}professional,**Master’s Degree in Management Studies**and a

**Diploma in Training & Development**and has been actively engaged in Training & Content Development during this period. As a

**Personal Finance Enthusiast**and an avid researcher of the subject, Deepak has delivered several Investor Awareness Workshops over the years covering areas such as Risk Planning & Insurance, Retirement & Goal planning, Tax Planning and a few other specialized areas. He takes keen interest in writing and has penned numerous articles for this blog, addressing some of the most relevant concerns that individuals face with respect to their finances.

^{CM}, CERTIFIED FINANCIAL PLANNER

^{CM}and marks outside the United States, including in India, and permits qualified individuals to use these marks to indicate that they have met FPSB Ltd.’s initial and ongoing certification requirements.”

**Watch this space for more insights on Personal Finance…**