Retirement corpus: How to beat inflation, avoid running out of funds | Personal Finance
The recently published sixth edition of Axis Max Life Insurance’s annual Bharosa Talks India Retirement Index Study (IRIS 6.0) points to a significant gap in retirement savings. Urban Indians have accumulated only 28 per cent of their target retirement corpus on average. Only 11 per cent believe their corpus will last their lifetime, while 39 per cent fear it may not last even five years. While those still working need to save more, retirees must manage their corpus more prudently.
Ideal corpus, withdrawal rate
The appropriate corpus depends on family size and retirement expenses. Financial planners regard 30–35 times expected annual expenses at retirement as a useful benchmark.
“If the corpus is below this benchmark, the retiree may need to control expenses or earn better portfolio returns,” says Deepesh Raghaw, Securities and Exchange Board of India (Sebi)-registered investment adviser.
Western retirement literature often cites 4 per cent as the appropriate annual withdrawal rate. “Indian data supports a rate closer to 2.5 to 3 per cent,” says Vishal Dhawan, chief executive officer (CEO) and founder, Plan Ahead Wealth Advisors.
Raghaw adds that a withdrawal rate above 3 per cent can become problematic, particularly for people retiring between ages 45 and 60.
How much a retiree can withdraw from the corpus also depends on whether they want to exhaust the principal or pass on a legacy. “A retiree who only wants the corpus to last for their lifetime may withdraw both investment earnings and part of the principal. Someone who wants to keep the corpus intact should withdraw only the earnings,” says Arnav Pandya, founder, Moneyeduschool.
Supplementary income sources like rent can reduce the amount withdrawn from the retirement corpus.
Use time-based buckets
While setting up the retirement portfolio, retirees can divide the total amount into buckets based on when the money will be needed. Keep funds required over the next one to three years in the first bucket. “Invest this bucket in very safe instruments to insulate it from volatility,” says Dhawan.
The second bucket should meet needs arising roughly four to 10 years later. “It may hold longer-term debt assets and a small allocation to hybrid assets,” says Dhawan.
Use a third bucket for needs arising after 10 years. “The longer horizon permits a more aggressive allocation. This bucket may include index funds and actively managed flexicap or multicap funds,” says Dhawan.
Choosing right asset allocation
The allocation to risky assets such as equity and gold should reflect the retiree’s risk profile. Corpus size is another key consideration. “A person with a large corpus who can meet expenses with a 30 to 40 per cent allocation to risky assets need not take additional risk,” says Raghaw.
Corpus size can also influence equity allocation in the other direction. “A larger corpus permits a somewhat higher equity allocation,” says Pandya.
The entire corpus should not be put into debt once a person crosses 60. “Maintain some exposure to risky assets because inflation can severely erode the value of the corpus,” says Raghaw.
Broadly, a person may allocate about 60–70 per cent to income-generating assets. “The remaining 30 to 40 per cent can help the portfolio keep pace with inflation after retirement,” says Dhawan. Those with a lower risk tolerance should invest more conservatively.
Use the right products
Retirees should allocate enough to income-generating instruments to meet their cash-flow needs. The choice of fixed-income instruments depends, among other factors, on the retiree’s age.
“Younger retirees may use debt mutual funds and equity arbitrage funds which are more tax-efficient,” says Dhawan.
Older retirees may use products designed for senior citizens like the Senior Citizens’ Savings Scheme (SCSS), which pays an 8.2 per cent annual rate of interest. They may also use bank or corporate deposits that offer higher interest rates to senior citizens. Reserve Bank of India (RBI) floating-rate bonds (8.05 per cent annual interest rate) are another option.
“An annuity plan can be useful when purchased at an appropriate age,” says Raghaw. Annuities bought at an older age give higher returns.
A systematic withdrawal plan (SWP) can also be used to generate cash flow. “Use an SWP from a debt fund rather than an equity fund. An SWP from an equity fund can damage the portfolio,” says Raghaw.
Equity index funds, exchange-traded funds, flexicap funds, multicap funds and aggressive hybrid funds can provide growth exposure. “Gold can deliver reasonable long-term returns but can also be highly volatile at times,” says Dhawan.
Real estate investment trusts (REITs) and infrastructure investment trusts (InvITs) can provide both growth and income.
Common mistakes
Retirees often underestimate life expectancy and plan only until age 70 or 75. With lifespans increasing, they should plan for a lifespan of 85 or 90 years.
Some retirees also become overly conservative. “Excessive conservatism can leave a portfolio vulnerable to inflation risk,” says Raghaw.
At the other extreme, retirees with an inadequate corpus take excessive risk to narrow the shortfall. “Risk can produce higher returns but can also destroy capital,” says Raghaw.
In the case of seniors with a large corpus, excessive spending in the early years can prove costly. “Early retirees may still face major expenses such as children’s education, marriage or home purchase. Drawing excessively from the retirement portfolio for these expenses can be risky,” says Dhawan.
The retirement corpus should be adequately liquid. Using too much of the corpus to buy property for rental income can block capital and leave seniors short of liquidity.
Finally, retirees should not assume that returns available at retirement will continue indefinitely. “Ideally, a person should aim to preserve the corpus and meet withdrawals from its earnings. Drawing down the corpus can cause retirees to run out of money in their 70s or early 80s,” says Pandya.
