Retirement planning is a very important process of estimating retirement corpus and also ensuring steady income to meet the monthly expenses after retirement. To estimate the retirement corpus needed by an individual, the income needed to provide for the monthly expenses must be considered. Since the monthly expenses of individuals are different, the retirement corpus needed after retirement will be also different because of the difference in lifestyle, although the standard of living of an individual might be reduced after retirement.
There are two ways of estimating the monthly income required after retirement namely:
- The expense protection method: This method focuses more on the monthly expenses of an individual based on their lifestyle after retirement and consider the current income less. The total expenses needed after retirement is determined by listing the expenses in detail and some expenses are written off based on certain assumptions that some will not occur after retirement. The expense protection method also put inconsideration the inflation rate and the future expenses are adjusted considering the rate per year which consequently will affect the purchasing power of money. The expenses will have to calculated at prices that are a bit higher than the current prices, this will allow such individual to save more and also to be on the safer side in the case of inflation.
The expense protection method also considers some expenses to be added after retirement while the cost of some other expenses increase significantly. For example, some compulsory expenses like health cost will increase due to ageing of the individual. This method is considered to be a bit complex because of the need to list all expenses after retirement in detail, any omission may result problem after retirement if not taken care of immediately.
2. Income replacement method: Using the income replacement method, the monthly retirement income needed is calculated based on the current income of the individual. Usually, the ratio of the monthly income needed after retirement to that of the current income is calculated. Certain expenses like tax payment, conveyance cost etc. are deducted from the current income since such expenses are not to be considered after retirement. Under the income replacement method, some factors like the amount of current income, the expected rate at which the monthly income is expected to increase, the number of years to retirement which will consequently determine how much you have to save monthly to meet the retirement corpus targeted at retirement.
The application of income replacement ratio is also crucial, the average expenses after retirement is about 75% of the current income although this might be different for individuals based on the differences in lifestyle.
Using any of the methods above, the life expectancy i.e. the number of years the income is to be generated by corpus must be considered, the life expectancy will form the basis for calculating the total corpus needed after determining the monthly income needed after retirement.