How much of retirement corpus can my SIP create?
Jignesh Pandit is 28 years of age and is looking at various options to save and grow his money over time. He has calculated that he can save Rs10,000 per month in an equity SIP and sustain this SIP well into the future. Here are some tenure options.
|Monthly SIP||Yield on SIP||SIP Time Frame||Contribution||Corpus Value|
|Rs10,000||11.5%||10 Years||Rs12 lakhs||Rs22.55 lakhs|
|Rs10,000||11.5%||15 Years||Rs18 lakhs||Rs48.11 lakhs|
|Rs10,000||11.5%||20 Years||Rs24 lakhs||Rs93.40 lakhs|
|Rs10,000||11.5%||25 Years||Rs30 lakhs||Rs1.74cr|
|Rs10,000||11.5%||30 Years||Rs36 lakhs||Rs3.16cr|
Since Jignesh is 28 years of age, he has a full 30 years to save via SIP and create a decent corpus when he retires at the age of 60. If he starts the equity SIP of Rs10,000 today and continues it for 30 years, then even assuming a conservative 11.5% return, he would have accumulated Rs3.16cr at the end of 30 years. One can argue that Sensex returns have been 17% over last 40 years but you need to appreciate that returns in the last 20 years have been much lower. Also, with debt yields falling, it would be ambitious to expect higher returns on equities on a sustained basis.
Corpus created; real challenge starts
This is where the problem starts. We create a corpus of Rs3.16cr at the age of 60 and think the job is done. The bigger question is what to with the money. A few ground rules! You cannot take too much risk as your appetite for capital loss is limited. Secondly, improved healthcare also means that most people live longer. You have a longer post-retirement life to make your corpus count. For example, if you were to live to the age of 90, you need to make the corpus of Rs3.15cr last for 30 years. That is a lot more complex than you imagine.
Risk limits and inflation
At the age of 60, when you only have the corpus of Rs3.16cr to fall back upon, you have limited risk appetite. Hence your corpus must be invested to the tune of 70-80% in low risk debt funds and only the balance can be in index funds or diversified large cap funds. So, the first challenge is that you are going to earn much lower returns.
The second challenge is of inflation because costs will continue to rise even after you retire. You cannot plan a fixed income from the corpus each year. The return on your investments will have to increase annually to factor in the inflation risk. These are two important considerations for managing your post-retirement corpus.
How about investing in a dividend plan of debt fund?
That sounds simple but it is not. Let us say after clearing your taxes and costs, you are left with a corpus of Rs3cr at the age of 60. If you invest that in a debt fund, you earn about 7% returns on an average. However, 4% will be taken away by inflation each year, so you are left with just 3% real returns.
Since dividends are taxed as other income, you will pay a tax of around 20%, so your post tax return is around 2.4%. Now, on a corpus of Rs3cr, a return of 2.4% would mean an annual purchasing power inflow of Rs720,000 or Rs60,000 per month. You don’t have to be a mathematical genius to figure out that this is insufficient for your expenses even at 60. The other option is to systematically draw down your corpus.
How and by how much to draw down your corpus?
In the previous plan, your corpus of Rs3cr is intact. Instead, you can drawdown the corpus plus returns over your lifetime and enhance your monthly inflows. Let us assume a corpus of Rs3cr at age 60, return of 7% and inflation at 4%. The biggest challenge is how much should you draw each month. Here are some scenarios.
|Withdrawal Percentage||First Withdrawal||Last Withdrawal||Corpus will Last for||Can draw down till age||Total Withdrawals|
If you opt for 3% withdrawal annually, you would start with a very small withdrawal initially, which may be insufficient. Also, in such cases, the corpus lasts till you are well over 100, which may be impractical.
If you opt to withdraw 6% of the corpus each year, then you start off with bigger inflows but the corpus only lasts you till the age of 82. This may be slightly risky for you as you are left with no funds after that.
The global benchmark is to withdraw 4% of retirement corpus each year which will ensure that your corpus lasts you for over 30 years even after considering inflation. However, since yields are higher in India compared to the Western markets, you can target to withdraw 4.5% to 5.0% of your corpus each year. That will last you well into your 90s. Also, since these are predominantly capital withdrawals, the tax liability will be marginal.
Remember, when it comes to retirement planning, it is not just the corpus size but how long you make it last that really matters!