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POSTED BY ON February 25, 2013 4:36 pm COMMENTS (19)
Dear Readers,
I am turning 45. Married with son admitted to professional college last year and daughter stepping in this year. I have been working for 23 years in IT industry and through some plain living and saving have built up some corpus. I have plans for an early retirement within the next 1.5 years, and I request some key inputs to execute the plan. Without going into the actuals, here are some details on the plan:
I. Retiral accounts (cumulative FDs, monthly interest FDs, debt mutual funds, tax free bonds, 1 jeevan anand policy completed 7 years, 1 ICICI lifetime super pension completed 5 years). The %age split of different investments are: (FDs+Bonds: 52%, Debt Funds:30%, Others: 18%). Portion of this generates monthly income & the rest keeps appreciating at FD/Bond rates (post tax).
II. Known future expenses: College expenses, marriage expenses, health charity etc:
These constist primarily of FDs: 70%, Debt Funds: 20% Equity & equity funds: 10%
1. College fund: To take care of all college expenses till undergraduate professional degree.If kids qualify for higher education with stipend then will go for it. Else will give basic life support till they get job.
2.Marriage expense for kids: Reasonable allocation for Marriage expenses.This is purely a lifestyle decision but costs increase each year. Right now it is around 15% of the total corpus.
3. Health fund: Currently covered by employer. After retirement Health insurance : (the annual interest from the health component will be used for paying health insurance). Currently 2% of total corpus. Need to increase this to atleast 4%
4. Emergency fund: 10 months of planned monthly expense. (Currently kept in savings bank for immediate liquidity)..
5. Monthly expense: will be a fixed %age (say 4%) withdrawal from the retiral component. This will be for food, clothing, casual visits to the doctor, electricity and telephone bills, & sparse outings.
6. House: completely paid off, no loans. Sufficient for 4 people, + aged mother. This is 1 floor of a duplex co-owned with brother.
7. Car: No loan. 7 yrs old now. If sufficient funds are available will go for replacement. Otherwise will maintain this one. Has been used only during weekends. Commute to office on two wheeler. This needs replacement. Both vehicles needed during retirement for casual transportation, dropping kids at bus stop, and emergencies..
7. Charity: Currently 1% of total corpus. If ever I work beyond the planned retirement date, will focus on increasing this component only.
8. Control expenses: No cable. No post paid cell plans, 1 credit card – no outstanding. (Used for any online purchases only of books etc, immediately paid off within due date). Never had (and will never have) A/C ofcourse. Rare outings to theme park or a multiplex are ok.
9. Tax: Withdrawals @4% rate, and annual appreciation in FDs attract tax. Total taxable income from retirement start date will fall in 20% tax bracket. Always on the lookout for parking funds to bring this to lower end of 20% bracket. I do not aim to breach the 10% bracket if this means higher risks in equity related instruments. Tax free bonds can reduce risk and also divert funds from taxable FDs. No withdrawals from any mutual funds for the 1st year. Delay withdrawal as much as possible for getting max advantage of indexation.
10. From now till retirement date I plan to:
– Create a corpus for house/transport maintanance: painting, minor repairs for house and vehicles.
– Optimize/diversify asset allocation, across investment avenues: increasing equity through sip (if needed)
– Stream line monthly income streams to get close to amount actually spent per month.
– Increase allocations within select items (like charity) above to get a better balance
– Firm up transportation options (renovate or buy car/2-wheeler)
– Provide for any unknown expenses (big question mark here :-))
Now the questions:
1. What are the red flags. Where can things go wrong ?
2. Equity (and equity funds) is 5% of total corpus. Does this need to be increased ?
3. Does the retirement component need to have equity for 4% withdrawal rate ?
4. Is term insurance required if 100% of retirement corpus is nominated to wife and kids ?
I have been following Jagoinvestor articles and forums for a few months now and really impressed with the good work people here are doing. Hope to see your valuable thoughts on the above.
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Dear FER, thanks for the updates. I do hope that dear FFC, ‘ll take care of the changes in his calculator you are asking for.
Thanks
Ashal
Dear FER, we ‘ll wait for your updates.
Thanks
Ashal
Dear Bhushan, well dome. Please accept my congratulations for such an detailed reply.
Thanks
Ashal
Dear FER, To answer your main query, here are the risks in early retirement:
1 – Time. It is the biggest enemy you have. If you retire early, you will have to live longer totally dependent on your nest egg. If you are walking in a desert, for short distance, you can safely calculate how much water you need to carry. If the distance is longer, then the uncertainty is higher. It is very difficult to estimate how much you will need.
2 – Probability of risk is higher. There are many events which, if happen, can severely dent your retirement corpus. Think about accident, major health problem, fire etc. Longer the retirement duration, higher the chances that they happen.
3 – No income from work. You may be fine now and may think you can work again later if required. But trust me. It is physically difficult to work after you cross certain age (say 55). Also when younger workforce is available at low cost, why would anyone employ you? So, it is better to prolong your working life when you can.
Coming specifically to your situation. I see two risks.
A – Yes, as you have suspected, not having exposure to equity is a risk. If for any reason you have few high inflation years (> 15%), then you will see that your debt fund is not sufficient. We had such periods in early 1990s. Once you start withdrawing from your principal, it starts eroding quicker and vanish in no time. Invest in Equity index funds (ETFs or large cap Mutual funds) as equity has better chance of beating inflation. Having rental income is also a good idea. But it is a difficult asset to maintain when you are 55-60 year old.
B – Inflation number: You have assumed a lower inflation number. It is better to plan for higher inflation number and be wrong, rather than plan for lower inflation number and proved wrong. Also, quality of life improves regulalry and it has its own ‘inflation’. Ex: Inflation of Electricity price might be just 5%. But the amount of electricity that you consume today is 5-10 times what you were doing 25 years back. So, although inflation is only 5%, your overall cost is may be higher by 10% year-on-year.
Regards,
Bhushan
Dear Bhushan,
Some real red flags there I must say ! And valid ones too and each of the item you listed is possible.
– I believe lower the withdrawal amount one can extend the longevity of the corpus. So i guess not splurging, and being disciplined to only spend on what is must is one way of addressing the time factor. In years of good growth or lower inflation, save more and use them during years of higher inflation or less growth.
– Also as Dear Ashal had suggested, taking up a part-time job is something which I am more seriously looking into now. If the going is good, the extra income can be saved off for future, or will come in handy if the going is not good for some years.
– In terms of unforeseen events, consider a scenario where one is employed and is suddenly rendered jobless due to an accident, or fire or whatever, this person is going to find it more difficult to get going, compared to another person who has planned reasonably well enough to save for future, create alternate income streams, and is better prepared for such eventualities. Just my thought. And yes longer the period, higher the probability of such events occurring. But eventually when one enters retirement at an age considered as normal, any of these events can still happen, and unless one is well prepared, it is difficult to avoid suffering.
– Yes I am planning to slowly increase exposure to equity – may be upto 15% (or more if I continue to be employed part time).
– Very good explanation on the electricity charges becoming higher over the years, due to higher consumption,.. fully agree with that.. And I am trying to increase the %age of inflation factor in my plan. Will update soon on this one.
Very thought provoking response Thanks a lot !
Regards,
Dear FER, We ‘l wait for your updates.
thanks
Ashal
Dear FFC, Ashal, and Bhushan,
Based on your valuable inputs, and after going through the retirement chapter of Dear Manish’s Financial planner book, I have made the following changes to my retirement plan:
1. Increased expected average inflation rate to 8%
2. Made provision for a maintenance and replacement fund: (2% of the total corpus now). This will be used for maintenance, upkeep and replacement of house hold durables like refrigerator, TV, two wheeler/car, and also regular upkeep of house – painting, repairs etc
I still have some questions: On the no of years in retirement to plan for Dear Ashal has suggested to plan atleast for 40 years.
Based on the numbers I had input in Dear FFCs calculator, I am getting a reasonable plan for 35 years. This also needs that I continue work for 3 years from now at current salary levels and also save a considerable sum towards the retirement corpus.
One thing that I want to consider here is after say 8-10 years, I expect both my kids to be reasonably self-dependent, and not depend on me for survival needs (food, shelter and education). At that point, I see a strong possibility to reduce my withdrawal amount by atleast 1/3rd. Dear FFC, currently the retirement calculator does not have the facility to reduce the withdrawal amount midway into the retirement period, and I am trying to understand how this can be added to the calculations.
Also the retirement calculator seems to calculate tax only on the monthly withdrawal amount. It assumes the remaining earnings on the corpus, which is added back to it and not spent, does not attract any tax. This may not be true if portion of the corpus (significant in my case) is in Bank FDs and taxable instruments.
Looking for your suggestions in this area. I will mail my calculation example for your reference.
Regards,
DEAR FER, whenyou are asking to retire @ age 50 & considering the life expactency of 85Y, we are looking for next 35Y of your life. Even if you ;ll not in physical fitness to drive the car in last 7-8 years, still there is good 25-28Y of remaining years for your car. Similar issues for other household articles, goods, gadgets. Please think over it.
Regarding Inflation assumption, it’s always good to expect high inflation & then facing lower one not the opposite. Even aftr retiring @age 50, please do not cut yourself off from job completely. My take ‘l be to engage yourself in a part time job or hobby or passion which may provide you a support income for next few years. Yes I’m not asking to go for a full time job. Your time ‘ll be spent good & you ‘ll not feel lonely.
Thanks
Ashal
Dear Ashal,
Valid points all.
I see your point that consumer and household articles, including cars need replacements multiple times over the retirement period. I only wanted to mention some of the ways to 1. extend life of articles, 2. eliminate need to buy things not required and 3. find alternate ways to meet what the articles will achieve for us. (like using a two wheeler or public transport in lieu of driving a car for example). I think I will still allocate some %age of the funds towards repair and replacement of very essential articles over a ‘long’ period of time. And also keep adding to the fund little amounts whenever feasible.
Again agree that it is safer to assume a higher inflation and save more up front rather than the other way round.
Yes. I am not ruling out taking part time job or consultancy work. IT industry particularly the R&D segment which I am in does not encourage part time work however. I was able to convince my current employer to take me as a part time employee for 4 months, when I needed more personal time to help my son with studies last year, but there was continuous pressure to convert to full time, which I yielded to finally. But I intend to keep myself open for work as long as it does not consume more than 4-5 hours on a daily basis including any commute time.
Thanks a lot again for your kindness.
Regards
You can also look at my second book bit.ly/Financial-planner-book , which has a chapter on the retirement planning , it also discusses about the X% withdrawal rule . You might want to just see that all the 10 chapters covered in the book is taker care in your life. It will be more planned than what it is right now . I hope 🙂
Manish
Dear Manish,
Thank you very much. I definitely want to buy the book. Just curious, is the book available for buying in pdf (ebook) form or hardcover is the only option ?
Regards
Dear FER, 300 months seems you have calculated for next 25 years. Well 6% inflation rate is a bit lower side assumption. I w’d like to have it around 8 or may be 9%. If Inflation cools down from here onwards & remain 6-7% i.e. below my assumption, I’m in comfortable position but the trouble is there If I assume 6% & actual hit is 8-9%.
There is more to it. As we are discusing your retirement, in all probability, you ‘ll replace 2 more cars, some TVs, some WMs, some ACs in your remaining life. So factor such things also. As you w’d have to live on this corpus for next 25-30-35 years, a slightly higher %age should be allocated towards Eq. to fight Inflation. For example your comfort zone is 15% Eq. I w’d like it to 25 or may be 30%. If you are not touching this 25-30% part for next good 15Years, my God you may earn a very handsome corpus by that time & hence may increase your WR if inflation forces you to do so for increased living expenses.
Thanks
Ashal
Dear Ashal,
I agree 6% is bit on the lower side. However I have also assumed a very conservative growth rate of 6.5% (post tax) on my investments. By moving more investments to medium term debt funds, and progressive shift to equity, the growth rate can go atleast to 8% post tax.
As you have advised, I have been doing SIP investments to mutual funds for around 1 and 1/2 years now. I will target 15% equity funds to be reached within next 1 and 1/2 years and then go from there.
I will also recalculate the the numbers with Dear FFCs retirement calculator with a higher inflation %age (say 8%), and see what my corpus requirement comes to.
Also on items like Car: I intend to maintain and prolong the running life of the car as much as possible, instead of replacing every 5 years. I still intend to use it only where it is needed like hauling luggage, or hauling more passengers etc. For personal use it will be mostly two wheeler, walking / cycling or public transport. My current car is shared with my brother and family, and has done only 12000 kms in 7 years.
Also I never intend to use AC at home at all !
Thank you for your insightful suggestions.
Regards
Dear Ashal and FFC,
Thank you very much for the quick responses. I have not thought about engaging with the financial planner so far. The forum here already had answers for many of the doubts I already had finance plan 🙂 . However I will definitely think about it going forward.
Dear Ashal, To answer some of your very valid queries:
How did I arrive at the X amount of Corpus:
For the monthly income part: I did a detailed study of my expense pattern for
the past two years and arrived at a estimate of the monthly “consumption” expenses
This includes food, clothing, basic medicine, medical insurance & telephone bill etc. The
Final amount of X is arrived at by multiplying this monthly number by 12/SWR,
where SWR is the safe withdrawal rate.
I had assumed 4% as SWR for this calculation to arrive at X. (So X = monthly * 300)
I have also assumed an 8% appreciation rate for X, and I did a spreadsheet to see how many years will the corpus last, if I continue to withdraw from the corpus at the initial SWR rate. I also increase the withdrawal rate every year at ~6% to account for inflation.
I took 4% as this seems to be the rate recommended by most sites on personal finance &
retirement. The results with 4% looked comfortable to me.
I have also done this spreadsheet with 3% SWR and 3.5% SWR. The X value will be
correspondingly higher with correspondingly higher number of years left. I have not frozen this number yet, but yours and other expert views on it will be most welcome.
For the other big ticket items like marriage, college expenses etc I have made calculations based on current market prices, tried to allocate full amount as if they were needed now. Then they are invested in primarily debt instruments, with a high weightage on bank FDs.There is also a small %age in equity. But primarily my expectation is it will grow by ~8%.
This allows it to grow at around 6% post tax on current interest rates. Since college expenses are in the next few years, any shortfall can be accomodated to some extent while I am still working.
As I said marriage and few other expenses are a question of life style and social factors, and one can only spend as much one has. So current estimate + 6% growth is what it will be. I only hope my current estimates are reasonable.
Login name: Yes. I need to keep this info discreet as long as I am employed gainfully. But
I do see that one can see the email id in the forum. Just curious ? Is it possible to suppress the full email id (though it is not my work email) from being visible ?
Sure I will try to discuss offline with you or the experts you have recommended if I
have to share more specific data.
Hope this information helps. Thanks again for your thoughtful questions.
4% withdrawal will depend on inflation. How many years have you estimated your corpus to last?
Ideally this match with the expected lifetime of the younger spouse.
I have a request. Can you please try out this calculator and let me know how it matches with your research?
http://freefincal.wordpress.com/retirement-calculators-3/retirement-planner-for-the-middle-aged-employee/
My calculators have been refined greatly by people close to retirement.
Thanks
Dear FFC,
I went through the retirement calculator spreadsheet and it looks very good. One thing that I see in your calculator is that it takes the monthly income requirement even for the pre-retirement period and calculates the monthly income starting from retirement first month after adjusting for the inflation during the preparation period. This was something I missed in my calculations earlier.
I am in the process of collecting all the inputs required for the calculator and will revert back to you if I need help.
Thanks again for this very useful tool.
Regards
Thanks. I would greatly appreciate if you could send me your feedback to my email found in my profile here.
As Ashal has suggested the best no-nonsense solution would be to contact a financial planner. You can contact Manish or one in your city. If you need help in picking one you let us know.
Having a planner draw up a plan will give you peace of mind.
Dear FER, At your current age of 45, you want to retire in next 2-3 years. i.e. by age 47-48. No issue, you can discuss it. Now do tell me, how did you arrived that X amount of corpus is enough for you to live from 2015 to age 85 i.e. year 2053? Have you ever tried to consider the impact of inflation on all these expenses listed & plan by you & other unforeseen, unplanned expenses?
How did you come to the 4% withdraw rate.
On a different note – your ID name Findependent Early Ritiree, indicates that you want to keep your privacy intact. No problem in that as you w’d have to disclose a lot of data for yourself. If you want to keep the discussion private, please take help either a paid financial planner or discuss in private with some regulars here in the forum like FFC, Ramesh, BanyanFA.
FYI – Even Dear Manish provide paid services. To opt or not ‘ll be your personal call.
Thanks
Ashal