Ensure a smooth transition to retirement

It is obvious that you save more if you spend less. What may not be so obvious is that managing your spending in the last five years of your working life can help you transition smoothly into retirement and, perhaps, even reduce your longevity risk — the risk that you will outlive your investments.

Trial retirement-experience Your spending can be categorised into discretionary and non-discretionary expenses. Discretionary expenses are spending that can be avoided. This includes buying luxury products and services. Non-discretionary expenses, on the other hand, are spending required to sustain your lifestyle. This includes food, clothing, rental and health-care expenses.

Non-discretionary expenses are more difficult to manage than discretionary expenses. You will most likely cut your discretionary expenses when your income falls short of expenses. Suppose your income for a month is Rs 1 lakh and your expenses amount to Rs 1.25 lakh. Which would you cut: your visit to the movies and restaurant or your grocery supplies for the month? Obviously the former.

You believe that grocery purchases and other basic necessities cannot be reduced. That is not true. Even as a working executive in your prime career, you can typically cut 5-10 per cent of your non-discretionary expenses without compromising on your lifestyle. And if you are a soon-to-be-retiree, you should cut even more during the last five years of your working life. Consider these five years as a trial phase for your retirement. You should strive to manage your household expenses within the cash flow projected for your retirement. This will help you make a smooth financial transition from your working life to your retired life.

Your post-retirement living is largely influenced by the lifestyle that you have maintained in the last years of your working life. Now, it is highly unlikely that your post-retirement passive income will support any extravagant lifestyle that you may have enjoyed in your working life. The choice then is not whether but when you want to cut your non-discretionary expenses. Individuals typically, prefer to reduce expenses after retirement. We believe you should cut your lifestyle expenses just before retirement.

It is emotionally less-stressing to have money and yet tightly manage your spending decisions. That way, you get the satisfaction of having managed your cash flows well. After retirement, managing your expenses is not a choice, because the scope for increasing your income is limited; cutting costs due to lack of adequate income can be more stressful. Besides, you will get accustomed to living within the budget, as you would have already practiced doing so in the last five years leading to your retirement.

Further, your retirement income may be in the form of stable cash flows if you buy annuity and bank fixed deposits or fluctuating cash flows, if you have a stock-bond portfolio. In either case, you will be forced to cut discretionary expenses if prices of non-discretionary items increase. So, manage non-discretionary expenses when you can and spend on discretionary expenses to have a more fulfilling life. You should develop a disciplined approach to spending. First, set up a separate bank account when you are within five years of your retirement.

Second, calculate the amount of money that you will require for your monthly expenses during your retired life, and transfer that amount to your newly set-up bank account every month. You should manage your non-discretionary expenses within this budget. And third, invest the cash flow saved due to lower spending on non-discretionary expenses in bank fixed deposits or in tax-free bonds; you can spend this investment on discretionary expenses during your retirement!

(The author is the founder of Navera Consulting, a firm that offers wealth-mapping and investor-learning solutions. Feedback may be sent to >knowledge@thehindu.co.in )

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