Opinion | Find out how much you should save to retire comfortably, plan accordingly

Retirement calculators are too complex for most people to understand, and this complexity hides the inbuilt optimistic and incorrect assumptions that they make. As a result, people are saving too little for retirement, retiring earlier than their finances allow them to, and overspending during the early years of their retirement. Those looking for a clearer picture should, instead, use one simple formula to figure out how large a corpus they really need for retirement.

How much money do you need to retire?

The simple formula assumes that inflation is equal to investment returns, net of capital gains tax. Hence, the two cancel out, and you can ignore both these aspects. This makes the formula very simple. We will get to the rationale for this formula later, but for now, an example of a typical couple will make it easier to understand it. A couple, let’s call them X, are both 45 years old, and they have stable careers which will allow them to work till they turn 60. The cost of purchasing a sufficient amount of life annuity will be roughly equal to the cost of them not purchasing a life annuity, and instead covering their own expenses till they turn 90. So, they have to plan for 30 years of expenses for their retirement.

The human mind can only relate to the value of money as it is in the present—it cannot relate to the value of money decades into the future. So, let’s only think in terms of the value of money today. For simplicity, let’s assume that this couple does not own a house, or that even if they do, they will sell it and pay rent. X conservatively estimates that their annual expenses during retirement would be ₹20 lakh in today’s value of money. So, they need to save ₹20 lakh multiplied by 30 (years) which is ₹6 crore (again, in today’s value of money). Most people are surprised that this number is so high.

Let’s assume that they have already saved ₹2.4 crore for retirement. The gap between the ₹6 crore they should save and the ₹2.4 crore they have already saved is ₹3.6 crore (in today’s value). That is the additional amount they must save before they can retire.

How much should you save each year?

If they both have stable careers, then they could reasonably assume that their salaries will grow at the rate of inflation. They could, therefore, save the same amount (in today’s value of money, that is, adjusted for inflation) in each of the remaining 15 years till retirement. The gap of ₹3.6 crore divided by 15 is ₹24 lakh. So they must save ₹24 lakh this year, and that amount plus inflation in the next year. If they cannot count on a stable career, then the calculation becomes marginally more complicated, and they would have to save even more each year.

The rationale

The most important assumption in the formula is that over the couple’s remaining lifetime, inflation is equal to investment returns, net of capital gains tax. In simple terms, the two cancel out, and you can ignore both. This makes the calculation very simple. This is a simplified description of why this is true.

This is not an investment recommendation but, hypothetically, if X invested their entire net worth in overnight debt mutual funds (which involve zero credit-risk and zero interest-rate risk), then their expected returns, net of long-term capital gains tax, would be close to the prevailing inflation. Even if X invested some portion of their net worth in equity, it would not materially change their expected returns. Firstly, they could typically invest only a modest portion of their net worth in equity. And they would have to reduce this allocation during retirement.

Further, as I have written earlier, there is no guarantee that returns from equity, net of capital-gains tax, will be more than inflation over a period of 10, 20 or even 30 years. Since X cannot be sure that equity will increase their returns, they must conservatively plan for returns, net of capital gains tax, to be equal to inflation over their remaining lifetime.

Changing your future

Finding out that there is a problem is the first step to solving it, or at least partially mitigating it. So, do this calculation today. If this indicates a problem, you could reduce your standard of living or postpone retirement, or let your children take a loan to fund their higher education. Knowing the truth, however frightening, will allow you to change it.

Avinash Luthria is a Sebi-registered investment adviser and advice-only financial planner at Fiduciaries.in