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Chris Degnen
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Copying a simple example from here, showing 4 deposits and 3 withdrawals.

Planning to retire in 4 months and draw monthly income of £1000 (present value) for 3 months, adjusted for inflation. APR is 8% and inflation is 4%. What should the pot be?

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Calculating the monthly rates, assuming effective annual rates.

inf = 0.04;
i = (1 + inf)^(1/12) - 1 = 0.00327374

apr = 0.08;
m = (1 + apr)^(1/12) - 1 = 0.00643403

To illustrate the calculation, say we know at month 3 immediately after the final deposit, the pension pot p should be £3010.57

In month 4 it will have grown by (1 + m) and the inflation adjusted withdrawal will be w (1 + i)^4, where w = £1000. So the pension will decrease like so

p = 3010.57
p = p (1 + m) - w (1 + i)^4 = 2016.78
p = p (1 + m) - w (1 + i)^5 = 1013.28
p = p (1 + m) - w (1 + i)^6 = 0

This can be calculated in one go using a formula

o = 4  .  .  the month number
n = 3  .  .  the number of months
p = 3010.57

((1 + i)^o (-(1 + i)^n + (1 + m)^n) w)/(i - m) + (1 + m)^n p = 0

and more usefully, it can be expressed as a formula for p

p = ((1 + i)^o (1 + m)^-n ((1 + i)^n - (1 + m)^n) w)/(i - m) = 3010.57

So we need £3010.57 in month 3 for inflation adjusted withdrawals of £1000.

Starting with deposit d and increasing it to compensate for inflation

p = d
p = p (1 + m) + d (1 + i)^1 = 2.00971 d
p = p (1 + m) + d (1 + i)^2 = 3.0292 d
p = p (1 + m) + d (1 + i)^3 = 4.05854 d

This can also be calculated with a formula

q = 3  .  .  the final month number

p = (d ((1 + i)^(1 + q) - (1 + m)^(1 + q)))/(i - m) = 4.05854 d

We know p = 3010.57

∴ d = 3010.57/4.05854 = 741.79

The above can be expressed as a formula for d

d = ((i - m) p)/((1 + i)^(1 + q) - (1 + m)^(1 + q)) = 741.79

So the first deposit will be £741.79

The next month the deposit will be £741.79 (1 + i) = £744.21 etc.

The first withdrawal will be £1000 (1 + i)^4 = £1013.16 etc.

Putting the steps together

inf = 0.04;
i = (1 + inf)^(1/12) - 1 = 0.00327374

apr = 0.08;
m = (1 + apr)^(1/12) - 1 = 0.00643403

o = 4  .  .  the first withdrawal month number
n = 3  .  .  the number of withdrawal months
w = 1000  .  the present value of the withdrawal amount

p = ((1 + i)^o (1 + m)^-n ((1 + i)^n - (1 + m)^n) w)/(i - m) = 3010.57

q = 3  .  .  the final deposit month number

d = ((i - m) p)/((1 + i)^(1 + q) - (1 + m)^(1 + q)) = 741.79

These same formulas can be used on a more realistically scaled calculation.

A more realistic calculation

For example, suppose someone at age 25 wants to withdraw $1000 per month present value from age 65 to 100. Inflation is 2% pa and interest is 3% pa (effective rates).

(65 - 25) * 12  = 480 deposit months
(100 - 65) * 12 = 420 withdrawals
(100 - 25) * 12 = 900 months overall

inf = 0.02;
i = (1 + inf)^(1/12) - 1 = 0.00165158

apr = 0.03;
m = (1 + apr)^(1/12) - 1 = 0.00246627

o = 480  .  .  the first withdrawal month number
n = 420  .  .  the number of withdrawal months
w = 1000 .  .  the present value of the withdrawal amount

p = ((1 + i)^o (1 + m)^-n ((1 + i)^n - (1 + m)^n) w)/(i - m) = 784011.41

q = 479  .  .  the final deposit month number

d = ((i - m) p)/((1 + i)^(1 + q) - (1 + m)^(1 + q)) = 606.00

The plan could be achieved by making 480 deposits, starting aged 25 at $606, increasing monthly in line with inflation, i.e. $607, $608, $609 etc.

The first withdrawal at age 65 will be $2208.04: $1000 present value, i.e. w (1 + i)^480.

enter image description here

enter image description here

Solution for a non-depleting annuity

In fact, a non-depleting inflation-linked annuity is not possible because the withdrawals will tend to infinity, as w (1 + i)^n when n -> infinity. However, as the OP's link states ...

"The study found that retirees ... can safely withdraw 4% of their starting money each year – adjusting annually for inflation – and have more left at the end of 30 years than they started with."

the calculation for capital required can be adjusted so that it is not depleted by a certain time, in this case 420 months. So, replaying the calculation above with the formula for p adjusted.

(65 - 25) * 12  = 480 deposit months
(100 - 65) * 12 = 420 withdrawals without depleting initial capital
(100 - 25) * 12 = 900 months overall

inf = 0.02;
i = (1 + inf)^(1/12) - 1 = 0.00165158

apr = 0.03;
m = (1 + apr)^(1/12) - 1 = 0.00246627

o = 480  .  .  the first withdrawal month number
n = 420  .  .  the number of withdrawal months
w = 1000 .  .  the present value of the withdrawal amount

p = ((1 + i)^o ((1 + i)^n - (1 + m)^n) w)/((i - m) (-1 + (1 + m)^n)) =  1216244.52

q = 479  .  .  the final deposit month number

d = ((i - m) p)/((1 + i)^(1 + q) - (1 + m)^(1 + q)) = 940.10

The plan could be achieved by making 480 deposits, starting aged 25 at $940.10, increasing monthly in line with inflation.

Again, the first withdrawal at age 65 will be $2208.04: $1000 present value, i.e. w (1 + i)^480.

enter image description here

enter image description here

The plot of capital can be extended by taking values of n beyond 420 months.

p = ((1 + i)^o ((1 + i)^n - (1 + m)^n) w)/((i - m) (-1 + (1 + m)^n))

enter image description here

Chris Degnen
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