Retirement income portfolio is created at retirement using the wealth that an individual accumulates in her retirement portfolio during her working life. This includes investments in provident fund, public provident fund, and national pension scheme. This week, we discuss whether retirees must spend more during their early years of retirement or in the later years.

Longevity insurance?

Imagine that a friend has gifted you a box of assorted cookies. Will you eat your favourite cookie first or last? For most, the answer would be last. Looking forward to a vacation often gives us more satisfaction than the vacation itself. Saving your favourite cookie for the last would, therefore, not be surprising. You cannot apply the same logic to retirement spending. That is, it is not optimal to postpone consumption in the initial years of retirement so that an individual can spend more in the later years. Why? For one, poor health can prevent an individual from enjoying travelling or fine dining in later years. For another, the individual can meet with an untimely demise. The amount in the retirement income portfolio will then unintentionally pass on to the legal heirs. The point then is to spend more in the initial years of retirement and yet not run out of money in the later years.

What should an individual do?

The answer is to look for a product that has features of longevity insurance. This is an annuity contract available in the U.S. An individual buys the contract from an insurance company at retirement that will pay a fixed sum of money from, say, age 75, till the person lives. This allows the individual to spend the rest of her retirement money from retirement till age 75 without increasing longevity risk — the risk of outliving her investments. The flip-side is that the legal heirs will not get any payment from the insurance company if the person buying the annuity fails to survive his/her 75th birthday.

Conclusion

A common alternative for retirees in India is monthly income deposits. These bank deposits pay stable income and can be renewed typically after 10 years at which time interest rates could be lower. This means higher cash flows during early years of retirement and lower cash flows during the later years. Importantly, it fits with the behavioural needs of retirees who are comfortable consuming income and not capital. It also allows retirees to intentionally transfer money (the deposit amount) to their legal heirs after their lifetime.

(The author offers training programmes for individuals to manage their personal investments)

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