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Planning For Retirement? Income Replacement Ratio Tool May Help

Adhil Shetty

We invest for our children’s education, save money for home and car purchase, but often miss out on planning for a crucial aspect of life – retirement. And even if we plan for it, the question of how much we need to save for retirement leaves us baffled. As a result, we build a corpus that is inadequate to meet our important retirement expenses. In such a situation, you can take help of income replacement ratio that can guide you in estimating your retirement corpus requirement.

It is usually assumed that you will require just a percentage of the pre-retirement income as you may not need a number of expenses after your retirement, and at the same time some new expenses may get added. So, it’s essential to calculate the pre and post requirement expenses for computing the income replacement ratio.

Although it is difficult to gauge the amount you would actually require after retirement, the income replacement ratio can give you a fair idea. Here is how it works:

Relevant Vs Non-relevant Expenses After Retirement

Taxes, transportation, work-related expenses may no longer be relevant once you retire. However, there can be new additions to expenses like medical needs, recreational activities or visiting children in other locations. While estimating the amount needed for retirement, you don’t have to put an exact value against each head, but an approximate value. It will give you a fair idea of the proportion of money needed after your retirement. This will take you to the next step of calculating the required annual income after retirement.

Calculate Your Retirement Corpus Using Income Replacement Approach

As a retiree, you must have taken care of major expenses such as home, education of children, their marriage expenses etc. Hence, the sum required to maintain a comfortable lifestyle post retirement would be a fraction of pre-retirement corpus need. It could be anywhere between 50 to 70 per cent of the pre-retirement income.

To ascertain the retirement corpus, first you need to calculate the present income, then estimate the growth rate of income over the years to retirement. In the next step calculate the years to retirement. Find out the last drawn income, i.e., income at the time of retirement and apply the income replacement ratio to this income to arrive at the income required for a healthy retirement. Let us understand this better with the help of an example:

Mr. ‘A’ has an income of Rs. 10 lakh per annum. His age is 35 years and he hopes to retire at the age of 65. The expected growth of income per year is 8%. Mr. ‘A’ calculates that he will need 60% of his last drawn income as an amount to lead a comfortable retired life. This is how he calculates the income

Parameters Value (In Rs)
Present income of Sachin (per annum)               1,000,000
Current age 35
Retirement age 65
Years to retirement 30
Annual growth rate of income 8%
Income at the time of retirement            10,062,657
Income replacement ratio 60%
Annual income required just after retirement to lead a comfortable life (per annum)               6,037,594

You can use excel or a financial calculator to estimate the present value (PV) of the required corpus that can generate an income of Rs 60.37 lakhs per annum post-retirement. It would be wise to review and revise the income replacement ratio on a regular interval to stay close to your retirement goal.

The writer is CEO, BankBazaar.

BankBazaar.com is a leading online marketplace in India that helps consumers compare and apply for credit card, personal loan, home loan, car loan, and insurance.