Posted by: Arti Bhargava on Jan 01, 2018, 12.24 PM IST
Gunjan is an independent journalist who has planned and saved well to meet her many goals. However, as far as retirement planning is concerned, she is intimidated by the idea of trying to estimate her expenses for nearly 30 years into the future. She wants to know how she can get started on evaluating her needs and the things she needs to watch out for.
Gunjan should start by listing down all that is known, in other words her current expenses. She must study them to figure which expenses were likely to continue in retirement. She will realise that some of them may not be there at all, such as education expenses of her children and rent on housing. Some expenses that are not very significant now, such as healthcare, may be much higher in retirement. Expenses such as holidays and visits, which may be lower now, given the likely preoccupation with her job and family, will be higher in retirement and they need to be provided for.
The next step for her is to estimate the amount she is likely to spend on these expenses in retirement. This will be higher than her current spend because the prices are likely to go up due to inflation. To estimate the cost at retirement she needs to figure out the years she has to retirement and the rate at which she expects the costs to go up each year—the inflation rate.
Gunjan must remember that not all costs rise at the same rate across different expenditures. While living expenses can be expected to increase at the average rate of inflation, medical, travel and leisure expenses are likely to increase at a higher rate. The cost at retirement for each head of expenditure can simply be calculated as (Current expense)*((1+ rate of inflation)^(Years to retirement)).
Underestimating or overestimating her expenses in retirement is an error that Gunjan must watch out for. Underestimating the expenses, inflation rate or years to retirement will make the expenses appear lower than what they are likely to be. Underestimating will lead to a situation of lower funds than what is required being accumulated.
Overestimating will lead to a situation of expenses appearing larger than what they are, and put pressure on Gunjan's current savings plan. Having said that, she should not worry about getting everything perfectly accurate. A long-term goal such as retirement will see modifications as her personal situation changes. The important first step for her is to make a realistic estimate of expenses in retirement given the current situation.
(The content on this page is courtesy Centre for Investment Education and Learning (CIEL). Contributions by Girija Gadre, Arti Bhargava and Labdhi Mehta.)