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Can you retire by keeping money only in FD or pension?

Posted on 18 Aug 2021
Author: Sayan Sircar

Tags: Retirement ; Choosing Investments ; Pension

7 mins read
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This post explores the pros and cons of keeping money only in fixed income throughout retirement

Can you retire by keeping money only in FD or pension?

📚 Topics covered:

Introduction
Assumptions
Using only FD and pension (half and half)
Using only FD without a pension
Using only pension and no FD
Using cash, income assets and equity
Special case: using only dividend-paying stocks

Introduction

Many investors wish to know if they can retire solely by keeping money in either FD or a pension plan. This method allows them to avoid growth assets like equity altogether.

As we discussed earlier in this post about post-retirement portfolio construction, a retirement portfolio has three parts or buckets:

Bucket 1: cash for short-term expenses (3-5 years) and emergency fund (12 months of expenses)
Bucket 2: debt assets for portfolio stability and income
Bucket 3: inflation-beating assets like equity MF and direct equity stocks

Read more on inflation-beating assets: Inflation: the impact on your goals and how to choose assets that beat it

This post will address various scenarios of a portfolio created only using buckets 1 and 2 which is cash and fixed income, and optionally some amount invested in a pension plan. Before proceeding further, it will be good to review the following since this post will assume familiarity with:

The wish of avoiding equity assets in retirement is common among investors

who have never invested in equity throughout their life due to various reasons
who have a belief that if their corpus is large enough, an FD/pension is all they need since it gives guaranteed income

In this post, we will club all the usual post-retirement debt investments (see this post for the list) like SCSS, Post Office schemes and bank FD etc. under the same bucket we will call “FD”. We need to keep in mind that interest rates in India have been falling for the last 10+ years and as the country becomes developed, rates will fall further thereby reducing the returns from FD and other debt schemes.

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Assumptions

Starting corpus is ₹7 crores at the time of retirement (the rationale for choosing this figure will be explained later)
Desired income in the first year of retirement is ₹ 1 lakh/month i.e ₹ 12 lakhs/year
Inflation in retirement is 7% which means that in 10 years, the monthly income needed to maintain the same lifestyle will be (1.07)^10 or ₹ 2 lakhs approx.
Pension return (pre-tax) is 5% (this annuity plan returns the corpus to the heirs post-death of the retirees)
Average tax rate is 10% during retirement (this will need adjustment as income increases)
FD rate (post-tax) is 4% today and reduces by 0.5% every 5 years

Using only FD and pension (half and half)

Only FD and pension

This corpus lasts 30 years since after that the FD corpus drops to 0 and the pension payout continues. Due to inflation, the purchasing power of the pension is now ₹ 15.75/(1.07)^30 = ₹ 2 lakhs/year which is 1/6th of the requirement of ₹12 lakhs/year. This is the risk of keeping money only in FD and pension. Post the death of the retirees, the pension investment amount of ₹ 3.5 crore goes to the heirs.

Here are some sensitivities between corpus in crores and the number of years in retirement it can support with multiple levels of monthly income with 50% in FD and the rest in pension:

Only FD and pension sensitivities

Using only FD without a pension

Only FD and pension

This corpus lasts a bit longer this time i.e. 31 years but there is no cushion of pension this time. The heirs do not get anything in this example.

Here are some sensitivities between corpus in crores and the number of years in retirement it can support with multiple levels of monthly income with 100% in FD:

Only FD and no pension sensitivities

Using only pension and no FD

Only pension and no FD

Here we keep the entire ₹ 7 crore in pension at 5% pre-tax which gives a payout of ₹ 700 * 5% * (1-15%) = ₹ 29.75 lakhs/year. In this case, we keep the excess above ₹ 12 lakhs in FD and use that when the pension amount falls short. Post the death of the retirees, the pension investment amount of ₹ 7 crore goes to the heirs. Unlike FD, the return of the pension is fixed for life. The plan lasts for 25 years post which only the pension plan continues. Note that due to the higher income, in this case, the tax rate is increased to 15%.

Here are some sensitivities between corpus in crores and the number of years in retirement it can support with multiple levels of monthly income with 100% in pension:

Only pension and no FD sensitivities

Using cash, income assets and equity

We have covered this in detail in this post. For 40 years in retirement, you can get ₹ 1 lakh/month inflation-adjusted income with a corpus of ₹ 5.25 crore which is expected to last for 40 years. However, unlike the FD/pension combinations above, this is not guaranteed and is more suitable for retirees with

long time horizon of retirement like FIRE (financial independence, retiring early) aspirants
who cannot accumulate enough corpus to avoid equity as in the cases above

Here is the sensitivity table for retirement corpus with equity investment allowed:

Testing retirement corpus - sensitivities

Here we plot expenses in the first year of retirement (growing with inflation) vs. starting corpus in lakhs. The green zone is where you need to be by either having a high corpus or lower expenses. Since corpus will be fixed post-retirement and fluctuate due to market movement, the only variable under control is managing the lifestyle expenses.

We have covered this same point for NRIs retiring in India in this article: Can NRIs retire in India with only safe investment options like a fixed deposit?.

Special case: using only dividend-paying stocks

In this article on creating a dividend-only retirement portfolio, a question that came from a Twitter user on this topic is this:

If i have 7 crore then why will I invest in stock to get 14lakh dividends yearly that too post retirement.FD will give 26 lakh safe and secure post tax

The context is how much should be invested in dividend-paying stocks to get ₹ 12 lakhs/year as inflation-indexed income. Since this income is post-tax, we assume a 15% marginal tax rate to calculate. Yearly desired income, pre-tax is ₹ 1 * 12/(1-15%) = ₹ 14.18 lakhs. If the dividend yield is 2% at the time of purchasing the stocks then the corpus needed is ₹ 14.18 / 2% = ₹ 706 lakhs or ₹ 7 crores. This is where the 7 crore corpus target used above comes from.

The dividend portfolio is

expected to provide income growing at inflation maintaining the purchasing power during retirement
capital gains of the stocks will likely increase the value of the original corpus leaving a substantial inheritance for the heirs. A modest 3% growth for 30 years on the stock portfolio, for example, leads to ₹ 7 crores becoming 7 * (1.03)^30 = ₹17 crores which will be valuable for the heirs

There are two assumptions regarding inflation and capital growth in the points above and if both assumptions are valid, this is one portfolio that

lasts indefinitely throughout retirement as long as the dividends keep growing
leaves a very large inheritance

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