Threat from the inflation: The inflation silently devours the purchasing power of money. That is over time, it makes you pay more rupees to buy the same list of items. Thus, during long retired lives, you face the dual challenges of not only creating ample regular income to replace the paycheque. But this is easier said than done.

How Inflation Impacts Retirement Savings

Impact on home budget

As in work life, in retirement too, inflation impacts the home budget. For eg. suppose a person retired in 2014 with a monthly budget of Rs 50,000. Due to inflation, in 2024, the same budget you may be able to buy what Rs 30,016* did in 2014, or almost 40% decline in purchasing power. To reinstate the purchase power, you might need Rs 81,251 in 2024.

Potential Returns on retirement savings

Since you need consistent income from your retirement savings, it restricts you to lower risk, regular income generating investments. Historically, returns from fixed income, debt investments may be considered one of the best avenues to invest, as they have marginally stayed ahead of inflation historically **.

Impact on future regular income

The need for consistent income also prevents most retired people from considering higher risk investments to enhance income. Over long periods, this forces them to withdraw from the retirement corpus from time to time to maintain purchasing power which progressively reduces retirement corpus and the regular income from it. This makes them vulnerable to outliving their retirement savings.

Impact of healthcare costs Historically

Healthcare costs typically rise faster than general inflation. In 2023, in India, medical inflation was 14%^, far higher than the general inflation of 4.38%*. Studies also indicate that in India, 60-80% of healthcare expenses^^ are borne by people from their own pockets, with health insurance protection being inadequate. Treatment costs for ailments typically rise during retirement. According to some studies, a retired person is likely to spend 1.5 times^^ more on healthcare compared to a person in active work life. Not surprisingly, health emergencies often force many retired Indians to withdraw from their retirement savings and cause irreversible decline in quality of life.

Possible ways to combat Inflation In Retirement

It is quite evident that wealth creation is essential even in retirement to combat inflation and seek to ensure retirement corpus in long retired lives. This is even as regular income is created from retirement savings for present and short term needs.

As in the past, one can earmark growth investments like those in equities to effectively combat inflation over longer periods of 8-10 years, or more. Research studies have shown that 80-90% of potential returns# from any portfolio of investments can be attributed to the mix of investments across asset classes. The idea is to benefit from the growth of equities in the long term by staying invested for the long term. To accomplish that objective, you will need to focus on the following aspects.

Invest idle cash

It is common for retired people to hold cash and keep large balances for emergencies or simply, just easy access. Money held in cash or digital wallets earn negligible returns.

Like before one can assess one’s emergency requirements, keep money equivalent 3-6 months of expenses, which can go up to 6-9 months, in a bank account and liquid funds. Rest of the cash or idle money can be directed to growth investments like equity mutual funds and equity oriented hybrid mutual funds.

Budget for current and future income

Emergency fund and money for regular expenses met with regular income can be say ~15% of overall investments constituting liquid and fixed income investments like fixed income debt mutual funds. Rest can be invested in growth investments. However, we suggest that you please consult your financial advisor before investing.

Seek tax efficiency

Saving tax on investment income can also help retirement savings grow better in the long run. Growth investments like equity mutual funds and equity oriented hybrid mutual funds like equity savings schemes and balanced advantage funds provide capital gains. This income has an advantageous tax treatment compared to interest and dividend income.

Capital gains on equity and equity-oriented funds older than 1 year are considered long term capital gains. They need to pay 12.5% long term capital gains for amounts exceeding Rs 1.25 lakh p.a., with amounts up to Rs 1.25 lakh being tax free. In comparison, interest and dividend income are currently taxed at the relevant income tax rate or effective tax rate of 31.2% for those in the highest 30% tax slab.

An Action Plan To Combat Inflation

Provide for healthcare costs: By having an emergency fund and adequate health insurance coverage, a person can not only be in a position to address health emergency expenses but also avoid the problem of excess or idle cash.

Seek to Ensure tax-efficient withdrawals: Minimising tax outgo, while generating regular income for current needs, can help bolster inflation combatting investments. A pecking order for tapping retirement investments for regular income helps. One can begin retirement planning with tax free retirement benefits like provident fund and tax free lump sum of National Pension Scheme (NPS). This can be followed by tax deferred investments taxed at lower rates such as capital gains bearing investments like equity and hybrid mutual funds. However, we suggest that you should consult your tax advisor before investing.

Invest unused regular income: In early retirement, there tends to be an income bulge from accruing retirement benefits and maturing investments. A lot of this income often tends to remain unused. This you may consider investing in equity mutual funds and hybrid funds. While small amounts can be regularly invested with Systematic Investment Plans (SIP), lump sums can take the Systematic Transfer Plan (STP) route.

Use thumb rules for guidance: Seek savings to gross income ratio is at least 10% with the ratio being savings from retirement income to retirement income before taxes or any deduction. Ideally, this percentage needs to be higher in early retirement when one receives retirement benefits.

Second, is the ratio of invested assets to net worth. This needs to be 50% or more. Invested assets constitute all financial investments including traditional investments, mutual funds, stocks but excludes self-occupied homes. Net worth is the value of all assets including self-occupied home adjusted for liabilities or obligations like outstanding loans. This measure indicates how much wealth is at work to generate future income. Higher the ratio, better inflation combatting capability, with growth investments raising the ratio.

Seek potential returns from growth investments: Equity and equity-oriented investments typically helps to potential returns in the long term, translating into higher savings. Here, investments in large cap index funds and large cap mutual funds can help. They have the lowest volatility among equity mutual funds. Hybrid funds like equity savings schemes and balanced advantage funds can also be considered. They invest in a mix of debt, equity and derivatives and change the investment mix to tap market opportunities and contain volatility.

Periodically review investment growth: Periodic performance review, ideally done annually, can help assess progress of growth investments and identify any corrective actions required.

In India, elders often bless the young with a life of 100 years. By smartly managing retirement savings, especially combating inflation, Indians can meaningfully contribute to realising those blessings.

Source Reference

* https://www.statista.com/statistics/271322/inflation-rate-in-india/

** https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3959885

^{^}https://www.livemint.com/money/personal-finance/medical-inflation-in-india-reaches-alarming-rate-of-14-reveals-report-11700634947658.html

^{^^}https://www.ncbi.nlm.nih.gov/books/NBK109208/

#https://blogs.cfainstitute.org/investor/2020/03/25/roger-g-ibbotson-what-works-in-asset-allocation/

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