Several news portals have reported that the government is considering a proposal to offer 40% to 50% of the last drawn salary as a guaranteed pension for central government NPS subscribers.
It may never come to pass (because if the subscribers’ NPS corpus is not big enough to meet this guaranteed pension, the shortfall would be borne by the government). Still, it is essential to appreciate if a pension equal to 50% of the last drawn pay is enough for retirement. The short answer is a big no!
This is a set of retirement planning slides I used at investor workshops. The aim is to convey the importance of retirement planning in a few slides to young earners.
1. Imagine how your monthly income will evolve in the future
The abrupt stoppage in income represents retirement.
2. Now imagine how your monthly expenses will evolve in the future
Expenses do not stop when income stops. So those who do not have the means to account for expenses when income stops better hope they are dead on or before retirement!
The expenses in the above graph seem to head for the roof. Let us rescale it over our expected lifetime.
In about 15 years after retirement, the monthly expenses, thanks to inflation, are higher than the last drawn pay!
If I had an (imaginary) monthly pension that equals my last drawn pay, I would only be financially independent for about 15 years after retirement. So we need to do a lot better!
When the pension is only 50% of the last drawn pay.
Therefore, a pension is necessary but only one component of a retirement portfolio. See: Creating the “ideal” retirement plan with income flooring!
So before you jump in and opt for that higher EPS pension, ask yourself if you have enough money to fund the higher expenses due to inflation and lifestyle changes.
Instead, think of Inflation-protected income (blue dot within the red circles below)
To generate this inflation-protected income, you need a corpus between ~ 25-35 times (depending on inputs) your annual expenses at the time of retirement (the earliest green dot). As you withdraw more and more from the corpus, it decreases and drops to zero, hopefully when you die and only when you die. Ensuring this is the third stage in retirement planning.
The second stage is to ensure our investments grow and hit the first green dot when we retire.
We need to do two things to grow the corpus. 1. Choose a productive but diversified portfolio; 2. Invest
One cannot choose to invest a constant sum because the monthly investment to be made immediately will be much larger than the monthly expenses.
We can increase our investment yearly until retirement to ease our burden. This would imply we must strive to invest as much as we spend.
This is easier said than done. Let us have a look at the second graph again.
In this picture, the gap between the monthly salary and monthly expenses increases as we approach retirement. If this is how our lives pan out, then we can invest as much as we spend with a little effort and discipline.
Unfortunately, our expenses grow in steps, as shown in green above. Call it lifestyle creep if you like. If we embrace every new technology that arrives, if we cannot distinguish between our needs and wants, if we succumb to peer pressure and buy what others buy, we will never be able to invest enough.
Meaning we are sowing the seeds for our future financial doom today.
Lifestyle creep, the desire to spend for today and enjoy when young, resides in all of us. What is needed is a definite boundary: We can spend how we wish as long as we can manage to invest as much as we can.
Safeguarding that boundary is the first and foremost step of retirement planning.
If you want to start your retirement planning, you can do so with an automated risk reduction strategy before and after retirement using our robo-advisor tool. For an illustration, see: I am 30 and wish to retire by 50; how should I plan my investments?
In summary, even if the guaranteed NPS pension of 40% to 50% of the last drawn salary becomes a reality, it will not be enough to handle inflation after retirement. Make sure you invest enough to fend for retirement independently.
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Dr M. Pattabiraman(PhD) is the founder, managing editor and primary author of freefincal. He is an associate professor at the Indian Institute of Technology, Madras. He has over ten years of experience publishing news analysis, research and financial product development. Connect with him via Twitter(X), Linkedin, or YouTube. Pattabiraman has co-authored three print books: (1) You can be rich too with goal-based investing (CNBC TV18) for DIY investors. (2) Gamechanger for young earners. (3) Chinchu Gets a Superpower! for kids. He has also written seven other free e-books on various money management topics. He is a patron and co-founder of “Fee-only India,” an organisation promoting unbiased, commission-free investment advice.
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