To answer this question you need to understand it depends on many factors including your desired standard of living, your expenses (including any medical expenses) when you retire.
Work out following matters to find out how much need for retirement.
1. Decide the age at which you want to retire.
2. Decide the annual income you’ll need for your retirement years. It is best to find out the annual income yourself. Generally speaking, it’s reasonable to assume you’ll need about 80% of your current annual income in order to maintain your standard of living. (We are talking about value in today’s money value without considering Inflation)
3. Add current market value of all your investments and savings.
4. Determine a realistic annualized real rate of return (net of inflation) on your investments. A realistic rate of return would be 6-10%
5. If you have a company pension plan, get an estimate of its value from your plan provider.
A Sample Calculation
Let us consider the case of Mr. Rohit a 40 year old man earning Rs. 6 lakhs per year after taxes. Let us take a look at his key factors:
1. He wants to retire at 65 years
2. He need around 5 lakhs or more of annual income post retirement
3. He currently has Rs. 12 lakhs in investment & savings
4. He will get company pension of Rs. 20,000 per month (Presume he retires at one grade higher than his current grade)
Now, we concluded that Rohit needs around 5 lakhs per year which comes to roughly 40,000 Rupees per month. If we less his company pension, he required to fund Rs. 20,000 from his own pocket to retain his current standard of living.
Additional Consideration: Rohit is in good health and has a family history of long live. He also wants to make sure he can inherit a sizable portion of wealth to his children. As a result, Rohit wants to establish a retirement fund large enough to enable him to inherit- and not eat into his principal amount – during his retirement years.
We will assume that Rohit should be able to earn 6% annualized returns (after considering inflation), he required retirement fund at least 40 lakhs or more (2.5 lakhs / 0.06).
As you can see – Rohit needs to accumulate around 40 lakhs before he retires in order to be cater to fund the Rs. 20,000 he will need every month after retiring.
Note: We never considered any taxes he would have to pay on the income he earn.
The Big Problem – Inflation:
Now, remember that all these numbers are in today’s Rupees. Since we’re talking about 25 years in future, we required to consider the effects of inflation.
In India the average Inflation is running above the 7% mark but is has been around the 8% range over the past many years. So, for our calculation we are going to keep inflation at 8%.
In Rohit’s case he needs 40 lakhs as of todays money 25 years from now. So when you consider inflation, we will multiply that number by 6.8485 (you can find out this value from Future Value Tables)
Inflation Adjusted Value = 40 lakhs * (6.8485) = 273 lakhs or 2.7 crores
You see the current 40 lakhs money will become 2.7 crore in next 25 years.This is the effect of inflation. Twenty-five years from now, Rohit won’t be spending 5 lakhs per year as now – he’ll be spending 17 lakhs per year.
If we consider Inflation @ 7%, then the retirement fund required will be only 2.17crores.
To explain in other words,40 lakhs todays money is same as 2.7 crore 25 years from now when country running inflation @8% for next 25 years.
If you get return for your investment 14% and actual return will be 6% after deducting inflation @8%.
You don’t need to take too much worry when you plan for retirement just keep in mind the inflation figure @8%.
When you continue with your retirement plan year after year, simply check the inflation figure each year and revise your contributions accordingly. Now we consider the average inflation @8% and our country witnessing average inflation @8%in next 25 years there is no further calculation required.