Archive / Investment Adviser (Level 2) / Miscellaneous Aspects of Retirement Planning

nism-series-xb-lower-inflation-impact-retirement-corpus-required[ INVESTMENT ADVISER (LEVEL 2) ]

In Jaspreet's retirement planning case (Rs. 6,00,000 current annual expenses, 20 years to retirement, 25 years in retirement, 9% investment return), what is the impact if pre-retirement and post-retirement inflation is 6% p.a. instead of 8% p.a.?

[ A ]Future living expenses at age 60 decrease from Rs. 27.97 Lakhs to Rs. 19.24 Lakhs, and the required retirement corpus drops significantly from Rs. 6.22 Crores to approximately Rs. 3.44 Crores[ CORRECT ]

[ B ]The retirement corpus required increases to Rs. 10 Crores

[ C ]Lower inflation has zero impact on retirement corpus calculations

[ D ]The required corpus becomes negative

Takeaway

Lowering inflation from 8% to 6% reduces Jaspreet's future living expenses from Rs. 27.97 Lakhs to Rs. 19.24 Lakhs and cuts the required retirement corpus from Rs. 6.22 Crores to about Rs. 3.44 Crores, so option A is correct.

Derivation

At 6% inflation, FV of expenses at age 60 = FV(6%, 20, , -6,00,000) = Rs. 19,24,281, versus Rs. 27,96,574 at 8%. The real discount rate also rises to ((1.09)/(1.06)) - 1 = 2.8302%, up from 0.9259% at 8% inflation. Corpus required = PV(2.8302%, 25, -19,24,281) = Rs. 3,43,62,416, roughly Rs. 3.44 Crores versus the original Rs. 6.22 Crores. This tests whether candidates grasp that lower inflation helps twice over — it shrinks the future expense to be funded and simultaneously widens the real discount rate used to fund it — compounding into a dramatically smaller corpus requirement.

Why the others fail

B — The retirement corpus required increases to Rs. 10 Crores

Lower inflation reduces future expense escalation and increases the real rate of return, which lowers the required corpus rather than raising it to Rs. 10 Crores.

C — Lower inflation has zero impact on retirement corpus calculations

Inflation is one of the most powerful compounding variables in retirement corpus calculations; it cannot have zero impact on the final required figure.

D — The required corpus becomes negative

The required corpus remains positive as long as living expenses are positive; a lower inflation assumption cannot make the corpus requirement negative.