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NISM Certifications · NISM-Series-X-B: Investment Adviser (Level 2) · Miscellaneous Aspects of Retirement Planning

Caselet: Mr. Menon retires with a corpus that earns a 8% annual return after tax, while inflation is 5%. He needs Rs 9,00,000 in the first year, rising annually with inflation, with withdrawals at the beginning of each year for 25 years. Using the real return approach, (1.08/1.05 - 1) is approximately 2.857%. Which approach correctly sets the discount rate for the growing annuity-due calculation?

The correct approach discounts a constant Rs 9,00,000 payment using the real rate of about 2.857% in an annuity-due. The real rate captures inflation growth in withdrawals, and annuity-due reflects start-of-year timing. Using 8% or adding the rates would misstate the corpus needed.

  1. AUse 8% as the discount rate and keep expenses flat at Rs 9,00,000
  2. BUse approximately 2.857% as the discount rate with a constant Rs 9,00,000 payment in an annuity-dueCorrect
  3. CUse 13% (8% + 5%) as the discount rate with a constant payment
  4. DUse 3% (8% - 5%) on a constant payment and treat withdrawals as end-of-year

Explanation

For an inflation-growing payment stream, the real rate (1.08/1.05 - 1) is applied to a constant first-year payment, with annuity-due since withdrawals are at the start of each year. Using 8% ignores inflation, 13% adds rates wrongly, and 3% with end-of-year timing is an approximation that conflicts with the stated beginning-of-year withdrawals.

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