RBI MPC on inflation: A 0.5% higher inflation may need Rs 77 lakh higher retirement corpus

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The Reserve Bank of India (RBI) has called for an extraordinary monetary policy committee (MPC) meeting on November 3 to respond to the government’s concern about inflation being persistently higher for quite a long period. While the experts continue to deliberate about this, the average individual continues to bear the brunt of inflation.

A higher inflation for a long period can hurt in many ways. It not only hurts by increasing some loan’s equated monthly installments (EMIs) and disrupting household budgets, but also makes it difficult for people to save an adequate amount for important life goals such as retirement.
A long-term goal like retirement requires substantial savings to face the uncertainties that life can throw up. Inflation has a huge impact on a retirement corpus target. This is because one has to deal with price rise not only during the saving phase, but also plan for a rise in expenses each year after retirement. “Planning for an adequate retirement corpus for individuals of any age is to ensure that their residual retirement corpus at the end of each year generates returns that can compensate for their inflating living expenses,” says Anil Rego, Founder and Fund Manager at Right Horizons Portfolio Management Services.

Let us take a look at how inflation impacts your retirement savings and what you should do about it.

Need to save Rs 77 lakh more if inflation goes up by 0.5%

The retirement kitty that you need to build depends on many factors. “The target corpus will vary depending on inflation, longevity and investment return assumptions,” says Rego. Even a small rise in long-term inflation means saving a significantly higher amount to meet the retirement target.

Let us assume that a person who is 30 years old has 30 years to retire and plans for a 30-year post-retirement life. Let us also assume the person’s current monthly expense is Rs 30,000. If the rate of expected return on the retirement corpus is 7%, then the person would need a corpus of Rs 3.36 crore at the age of 60. This amount, arrived at by factoring in inflation of 5%, would allow the person to continue to have a similar lifestyle as now. However, if inflation goes by 0.5% – from 5% to 5.5% – the person would need to save Rs 76.74 lakh more.

This shows why inflation becomes a very critical factor in determining the size of your retirement corpus.

Why this extraordinary MPC meeting?

The RBI has a mandate to control inflation and is given a retail inflation target of 4% (+-2%). However, except for the current period, inflation has never remained above the highest tolerance level of 6% consecutively for 9 months during the last 8 years of this government. “CPI (Consumer Price Index) inflation has remained above 6% since January 2022 and was 7.41% in September. The high inflation rate in the last few quarters is mainly a consequence of external price shocks,” says Rego. This is the reason why the government has asked the RBI to explain why it has not been able to rein in inflation so far.

Inflation in 2022

An ideal inflation rate to consider while planning for retirement corpus

India is a developing country that is anticipated to grow at an above-average rate in the foreseeable future. Any growing country cannot grow rapidly without having some amount of inflation. So, inflation is a reality that we have to live with and plan for. While retail inflation measures the average price rise of several items, the impact individuals feel may be much higher than this rate.

Retail inflation Last 8 years

“In the long term, 5-6% inflation assumption is adequate as we are moving towards a $5-trillion economy. However, investors should take into account their personal future expenses as some categories such as luxury products and tourism can witness a higher rate of inflation,” says Rego. Moreover, there is an above-average rise in prices of healthcare, and medical expenses are the most critical expenses in late retirement years.

At the accumulation phase, when you are earning, you can make some adjustment to deal with unexpected higher inflation. But once you retire, you may not be able to do much if inflation rises unexpectedly. Therefore, one needs to plan retirement carefully and ensure that such shocks can be absorbed.

So, if you are planning to retire in the next 10-20 years, it would be prudent to factor in a higher rate of inflation. “Terminal inflation rate can be even 4% 30 years down the line. However, it would be safer to assume 5-6% inflation rate if one is planning to retire in 10-20 years,” adds Rego.

Even if your retirement phase is more than 20 years aways, it would make sense to plan a retirement corpus target with a higher inflation. Bring the rate down only after the economy experiences many years of lower inflation.

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