Archive / Investment Adviser (Level 2) / Miscellaneous Aspects of Retirement Planning

nism-series-xb-emerging-living-expense-shortfall-pension-gap[ INVESTMENT ADVISER (LEVEL 2) ]

In Case 4, Mr. Smart's living expenses equal his pension in Year 0 (Rs. 4,80,000). Why does an ongoing living expense shortfall emerge in Year 1 and expand every year thereafter?

[ A ]Because the pension is cancelled by the employer after Year 1

[ B ]Because income tax rates increase by 10% every year

[ C ]Because living expenses grow at 6% inflation while the pension grows at only 3% (50% indexation), creating an expanding annual gap between living costs and pension income[ CORRECT ]

[ D ]Because Mr. Smart is forced to buy corporate debentures

Takeaway

A living-expense shortfall emerges and expands each year because living expenses inflate fully at 6% while the pension grows at only 3% under its 50% indexation formula, so option C is correct.

Derivation

In Year 0, living expenses and pension both equal Rs. 4,80,000, so there is no gap. From Year 1 onward, living expenses compound at the full 6% inflation rate while the pension compounds at only half that rate (3%), so the two figures diverge every single year rather than staying matched. By Year 1, living expenses reach Rs. 5,08,800 against a pension of Rs. 4,94,400 — an initial gap of Rs. 14,400 that widens further with each passing year due to compound divergence. This tests whether candidates can identify the precise mechanical cause (differential compounding rates on two separate cashflow streams) behind a shortfall that starts at zero but grows structurally worse over time.

Why the others fail

A — Because the pension is cancelled by the employer after Year 1

The employer pension is guaranteed for the retiree's (and spouse's) lifetime and is not cancelled after Year 1; the issue is its lack of full inflation indexation.

B — Because income tax rates increase by 10% every year

Income tax rates do not automatically increase by 10% every year; the emerging gap is driven purely by the divergence between expense inflation and pension indexation.

D — Because Mr. Smart is forced to buy corporate debentures

Retirees are not compelled or forced to purchase corporate debentures as part of any statutory retirement framework.