Avoid overspending, financial mistakes in early years of retirement

High inflation, even if it is predictable, devastates the retirement of people who do not study personal finance in detail. I have previously written that the post-tax returns on our entire corpus over our lifetime will likely be in the ballpark of inflation. Also, a 60-year-old (let’s call her ‘X’) should plan that her corpus lasts roughly till the age of 90, i.e., for 30 years. Hence, she can spend one-thirtieth (i.e. 3.3 per cent) of her corpus in her first year of retirement.

 

Persistent high inflation in developing countries, including India, confuses people and makes them spend much more than they should during retirement. For simplicity, let’s assume that people live exactly till the age of 90. And let’s start with an imaginary world with zero inflation and zero post-tax interest. Here, the arithmetic is very simple. Let’s assume that X has a corpus of Rs 10 crore, spends Rs 33 lakh in the first year of retirement and is left with Rs 9.67 crore at the end of the year. It is clear that X’s corpus has reduced in the first year of retirement. And this helps X to realise that she should not spend more than Rs 33 lakh each year. X continues to spend Rs 33 lakh each year and exactly at the age of 90, X’s corpus drops to zero.

 

Now consider a high-inflation developing country. Let’s assume a conceptually similar situation of inflation of 6 per cent and post-tax interest of 6 per cent. X is tempted to spend the Rs 58 lakh of interest income in the first year of retirement. Luckily, she happens to have a competent financial planner who convinces her to spend only Rs 33 lakh in the first year of retirement. She withdraws this Rs 33 lakh on the first day of the year and the remaining Rs 9.67 crore earns an interest of 6 per cent, which is Rs 58 lakh. Hence her corpus at the end of the year is Rs 10.25 crore. Due to inflation, her expenses in the second year of retirement grow to Rs 35 lakh but despite that, each year her corpus keeps increasing. 

 

In the year when she is 73 years old (in general, at the beginning of the year), her expenses of Rs 71 lakh are now more than her interest of Rs 68 lakh. Hence at the age of 74, her corpus at the beginning of the year of Rs 12.06 crore is marginally less than it was one year earlier. Her expenses keep growing, her interest keeps reducing and her corpus keeps dropping gradually each year.

 

In the year when she is 82 years old, her corpus at the beginning of the year is Rs 9.61 crore. For the first time, it has dropped below the corpus on the day of her retirement. Her expenses are now several times her interest. So, terrifyingly, her corpus is dropping rapidly each year.

 

Finally, in the year when she is 89 years old, both her corpus at the beginning of the year and her expenses are Rs 1.81 crore. Hence, her entire corpus is spent by the last day of her life when she turns 90 years old. High inflation was the cause of all her confusion. So, it is simpler for X to do the calculation assuming the imaginary world of zero inflation and zero post-tax interest income.

 

The writer is an hourly-fee financial planner and a Sebi RIA at Fiduciaries.in. He was a private-equity investor for 12 years