Living serene, calm and peaceful retirement life should be one of the most important financial goals for each of us. This goal can be attained only when we have enough retirement funds with us and we are financially independent post-retirement. Be it the interest income, rental income, dividend income or any income but retirement fund should be on our priority list because it takes a considerable period of time to build an adequate retirement fund.
Calculation of retirement fund is based on several factors and most of which are the assumptions, however, taking assumptions are not bad not making mistakes while taking assumptions can be fatal because retirement planning is a long-term task and a single mistake can make a severe dent in your post-retirement life. Below are some of the mistakes which one needs to avoid while calculating retirement fund.
Basic assumptions are taken for the calculation done in the following article:
- Current Age: 30 years
- Retirement Age: 60 years
- Life Expectancy: 85 years
- Inflation: 6% p.a.
- Investment Growth Rate Pre-Retirement: 12% p.a.
- Investment Growth Rate Post-Retirement: 8% p.a.
- Medical Inflation: 10%
- Capital Withdrawn: 3% to 4%
- Tax Rate: 10%
Starting Late to save for Retirement Fund
Start saving for your retirement from the day you starts earning. In general people rush to achieve other goals like buying house, buying car, children education and marriage first and then think about post-retirement life but the late you start the more you need to save and there may be chances of not accumulating sufficient retirement Fund at all even if you increase the investment amount per month as you approach retirement. So it is better to start early.
For example, investing ₹ 15,000 for 20 years will accumulate Fund of ₹ 69.31 lakhs at 12% p.a. taking 6% inflation into account. Even you increase the investment amount to ₹ 35,000 per month, the accumulated Fund would be ₹ 1.62 crores. On the other hand, if ₹ 15,000 is invested for 35 years till retirement age of 60 years, the accumulated Fund will be ₹ 2.14 crore.
Inflation is not considered
Most people consider a conservative rate of return on the investment but forget to calculate the inflation-adjusted return rate. For example, if you take a rate of return on investment at 12% p.a. but forget to consider the inflation of 6% p.a. then ₹ 15,000 invested per month for 35 years would fetch a humongous return of ₹ 9.65 crores.
However, the same amount invested per month for 35 years but after considering the inflation rate of 6% p.a. would reduce the return to ₹ 2.14 crore from ₹ 9.65 crores.
Expenses not fully accounted for
While calculating the retirement Fund, current monthly or yearly expense is taken as the base of the calculation but we tend to forget during the course of employment, expenses on travelling is somehow limited but after retirement, there may be an increase in the expenses on travelling. Similarly, Medical expense tends to increase with age, so one cannot assume that medical expenses would remain the same as now. So while calculating retirement Fund the expenses on travelling and medical needs to be properly ascertained.
Current investment is not considered
As you start earning, you become the member of EPF i.e. employees provident fund which means you start saving towards your retirement Fund but at the time of calculating the retirement Fund needed, one tends to forget the amount already saved or currently saving per month towards the same. So while calculating the required retirement Fund one needs to take current savings into account together with the current expenses.
For example, if you and your employer contribute ₹ 1,800 per month into EPF for 35 years, then at the rate of 8%, the accumulated Fund would be ₹ 82.58 lakhs. So at the time of calculating the retirement Fund, you take deduct this amount from the required Fund.
Same Growth Rate pre-retirement and post-retirement
The risk-taking capacity of the investor reduces with age. There is a law of investing which says
“Equity Portion in your investment kitty must be 100 minus your age”.
Following the same law, the return on your investment can never remain the same. Once you enter into the post-retirement age, you risk taking capacity reduces and thus the rate of return also reduces. The equity portion in your investment kitty reduces and the weightage of debt portion increases, so the rate of return on investment before retirement and after retirement should be adjusted as we have assumed that pre-retirement rate of return is 12% p.a. and post-retirement the same is reduced to 8%.
Inflation for all expenses are taken the same
We have already discussed that all expenses can never remain the same. Few fades away with the age like child education, child marriage or EMI but few increases with the age like medical and travelling. Not only the spending increase with time but the inflation rate particularly for medical expenses rise faster than day-to-day expenses. Recently inflation rate of medical expenses is forecasted to be double-digit i.e. approx. 10% p.a. Similarly, travelling expenses for domestic tours are set to rise higher than the inflation rate, however, travelling expenses for international tours is highly dependent on the currency exchange so it may see either similar rise in inflation rate in comparison to domestic travelling or may see higher than domestic travelling also.
Huge Withdrawn from Capital
Depending only on return on investment is not always the case. Sometimes huge withdrawals from the retirement fund are required. This unexpected or unforeseen withdrawal put a severe dent in the remaining retirement age results into quick erosion of the funds. A safe withdrawal rate is below 5% which you can withdraw each year without running out of money throughout your post-retirement life.
If one accumulates ₹ 2 crores as a retirement fund and expected growth rate post-retirement remain at 8% p.a. then a 4% withdrawal each year would result in actual erosion of approx. 2% (keeping 6% inflation intact) of retirement funds each year.
Forget taxation aspect
Lastly, retirement does not means retirement from paying taxes. One should not forget the taxation part on the return on investment. Most of the debt schemes such as fixed deposits, senior citizen savings scheme, post office monthly income plan etc. are not tax-free. Similarly, systematic withdrawal plans from debt mutual funds attract tax at the rate of 20% after indexation. So while calculating the retirement fund, one must choose investment options where tax outgo is relatively lesser.
Not Reviewing your Retirement Planning Regularly
You are only half-way through if you have decided the required investment amount, chosen the investment plans and executed the retirement planning. Reviewing the retirement plan for your required returns is as important as choosing the right asset allocation. Since retirement planning is long-term planning sticking to a single strategy or a single investment plan may adversely impact the output. Any event which affects your savings or expenses needs to be considered in your retirement planning and your calculation for retirement funds needs to be re-examined and realigned according to it.
With leaps and bounds rising in the standard of living and efficient retirement fund planning has become the need of the hour.