Underfunding of the retirement goal

A retirement plan is built years, often decades, before it is actually tested. A lot can go wrong with the guesses made along the way.

When the guesses turn out too optimistic, the corpus that gets built falls short of what retirement actually costs. That shortfall is underfunding, and the workbook is blunt that a retiree who discovers it late has far fewer ways to fix it than one who catches it early.

The workbook names 3 broad causes of underfunding. Relevance of expenses: the mix of what a retiree spends on changes after retirement, and missing a category, such as health, drains the corpus meant for something else. Level of expenses: the amount needed can rise or fall over time, and the corpus has to be resized to match. Performance of investments: if the corpus was built assuming a 10% return and it actually earns less, the accumulated saving falls short of the target, purely from the return gap.

Once underfunding is discovered, the workbook lists the fixes: postpone retirement, which both adds saving years and cuts the years the corpus has to fund; move to a less expensive lifestyle; or take up a second career. The earlier a shortfall is caught, the more of these options remain realistic — caught only at the retirement date itself, the choices narrow sharply.

Mr Kulkarni plans to build a Rs 1 crore corpus by age 60, saving Rs 4,359 a month from age 25 on an assumed 8% return — the workbook's own example.

Suppose his investments actually earn only 6% over the 35 years instead of 8%, because he kept too much of the corpus in low-return deposits. His accumulated corpus at 60 falls well short of Rs 1 crore. He discovers this only at 58, two years before he had planned to stop working.

With so little time left to add to the corpus, his realistic options are narrow: work two years past 60 to add more savings and shorten the years the corpus must fund, cut his planned retirement lifestyle, or plan on part-time consulting income in his early retirement years to reduce how much he draws from the shortfall corpus.

Chapter 1, section 1.5 (Risk of Underestimating Retirement Goals), sets out the three causes and their fixes, following directly from the delayed-start illustration in section 1.1.1 that shows how a shortfall compounds. Expect a scenario question naming one of the three causes and asking for the appropriate corrective step.

• The three causes are distinct — relevance of expenses (the wrong categories), level of expenses (the wrong amount) and investment performance (the wrong return) — a case-study question often specifies which one applies.
• Postponing retirement helps twice over: more years to save, and fewer years the corpus has to support. It is not just "delay and hope."
• The earlier underfunding is caught, the more fixes remain available. A shortfall discovered at the retirement date has far fewer realistic remedies than one caught ten years earlier.
• Do not confuse this general risk with sequence-of-returns risk, which is a specific, narrower risk about the order in which returns arrive during withdrawal, not about the return assumption being wrong overall.