Retirement planning starts with a number. A sum of ₹3 crore, expenses of ₹80,000 and a withdrawal rate of 4%. The math on paper looks good. It works for about 25 years.
That is the problem. Many people live longer than 25 years after they stop working. A person who retires at 60 might live to 85, 90 or even more. The money needs to cover all of that time. This gap between the planned time and the actual time lived is called longevity risk.
Why longevity risk matters more than before
Life expectancy in India has been growing for years. Better health care, less child deaths and better food have made people live longer. A person who retires now has a chance of living into their late 80s.
The usual retirement plan assumes a 20 to 25-year time frame. For someone retiring at 60 this means planning until 80 or 85.. The end part of the time frame the people who live to 90 or 95 is increasing. For them the money has to last 30 to 35 years. The later years often come with more costs for health care.
The risk is not just living longer. It is living longer while spending more on health with years of work behind and with inflation making every rupee less valuable.
The withdrawal rate question
The used 4% rule, which says to take 4% of the money each year adjusted for inflation was based on US data with a 30-year plan. For a retiree with a 30 to 35-year plan and Indian inflation of 5-6% a 4% withdrawal rate may be too risky.
Advisors in India now suggest 3% to 3.5% as a starting withdrawal rate for retirees. At 3.5% a ₹3 crore amount gives ₹10.5 lakh each year or ₹87,500 every month. At 4% it gives ₹12 lakh or ₹1 lakh a month. The difference seems small.. Over 30 years it decides if the money lasts or runs out.
The withdrawal rate should be tested for the order of returns. A crash in the five years of retirement along with taking out money can hurt the money permanently. A retiree who planned for the situation may still fail if the returns are not good.
Why equity still belongs in the portfolio
One idea when planning for a life is to move everything to safe options. Fixed deposits and debt funds protect the money. They do not protect the buying power of the money.
Over 30 years of retirement inflation at 6% cuts the value of ₹1 lakh to about ₹17,000. A portfolio in debt instruments that earns 7% cannot keep up with that. Equity, with its ups and downs has given higher long-term returns and a part of the money needs to stay in growth assets to fund the later years.
The bucket strategy, where the first part holds two to three years of expenses in instruments and the rest stays invested in equity and hybrid funds is one way to plan. The short-term part covers costs during market drops. The growth part helps the money stay ahead of inflation over decades.
The healthcare buffer
Medical costs go up with age and insurance does not cover everything. Outpatient visits ongoing medicine and costs that do not require hospital stays are usually not covered. Premiums also get more expensive as a person grows older by a lot.
A separate health buffer, least 50% of the health insurance coverage is worth setting up along with the retirement money. For a couple with a ₹25 lakh coverage that means a ₹12.5 lakh in liquid or debt funds set aside for health expenses that insurance does not pay for.
The role of guaranteed income
For retirees who want to be sure some of the money can be turned into a guaranteed income. Annuities give a set payment for life but the return is lower than market-based investments and the money is usually not available for anything else.
The National Pension System (NPS) offers an idea. At the end part of the money can be used to buy an annuity giving a pension. For a retiree with a time ahead a guaranteed minimum income reduces the risk of running out of money in the last years.
Planning for the end
The average retirement lasts 25 years. Some last 35. Planning for the average is not enough when the result of running out of money is serious.
One way is to plan for a time than expected. A 60-year-old planning for 35 years of 25 has a smaller yearly withdrawal but the money is more likely to stay. The extra safety costs some lifestyle in the years but protects against the worst case.
Another way is to keep some options in the plan. If the money does well withdrawals can go up. If it does not some spending can be cut. A plan that cannot change with situations is weaker than one that can.
What retail investors should take from this
Longevity risk is not one choice. It is the result of a withdrawal rate, a way to invest a health buffer and a guaranteed income all set for a time that may be longer than expected.
The withdrawal rate should be a bit careful. The investment should have some equity, in retirement. The health buffer should be separate and big enough.. When certainty is important some of the money should be used for a guaranteed income to cover basics.
The retiree who plans for 25 years and lives for 35 has a problem. The one who plans for 35 and lives for 25 has money. The second situation is easier to manage.
FAQs
1. How long should I expect my retirement to last?
Planning for 30 to 35 years is safer than the 25-year plan. A person who retires at 60 may live to 90 or more and the years often have more health costs. Planning for the time reduces the chance of running out of money in the last years.
2. What is the difference between longevity risk and inflation risk?
Longevity risk is the chance of living than the money was meant to cover. Inflation risk is the chance that rising costs reduce the buying power over time. The two are linked. A longer retirement gives inflation time to grow which is why both need to be planned for together.
3. Is the National Pension System a way to deal with longevity risk?
NPS has a way where some of the money can be used to buy an annuity when leaving, giving a pension. For people who want an income that cannot be lost this is one of the easier options. The downside is that the money used for the annuity is locked in and not available for uses.
4. What happens if I use much of my money for an annuity?
The guaranteed income is higher. Flexibility is less. Money in an annuity cannot be used for surprises giving to others or new chances. Most advisors suggest using enough for basics and keeping the rest in investments for growth and options.
5. Can I take money if my investments do well?
Yes. A plan that can change allows withdrawals when the money does well and lower withdrawals when it does not. This change helps the money longer, than a fixed withdrawal that ignores market trends.
