“In the annuity market, the amount remains fixed and so at the beginning, it might be a decent amount but as the years go by, the value of that money reduces. In this, we are assuming that the withdrawal will go up by 6% every year and this is also after taking into account a 10% capital gains tax,” says Harsh Roongta, Founder, Fee Only Investment Advisers
What do you mean by systematic withdrawal plan (SWP) because a lot of times we tend to associate this particular feature or tool with retirees and for post retirement benefit. But that does not mean that other people who have other types of non-retirement goals lined up, cannot add this feature in their portfolio if they want to.
As the name suggests, SWP comes from a corpus from which you keep withdrawing something on a systematic basis. The reason it is very relevant for senior citizens who are retired is that just like a systematic investment plan (SIP) does rupee cost averaging, a systematic withdrawal plan does the same for withdrawals.
SWP is something on which there is very little focus. For retirement, the whole focus has been on the accumulation phase during the time when you create that corpus. There is very little study on when you need the money, for your pension and at that time, the variables are assuming what is the amount of corpus you have, what will it earn, how long you will live, what is the amount you can withdraw so that the corpus lasts for your lifetime.
Now these are four variables and each is a separate issue and the only product that currently caters to that is the life insurance annuity product, which gives a fixed return for as long as you live. Now obviously they are taking all the risks; they are taking the risk for how long you will live and what interest rates it will earn and that amount is small. So that is a market that is not hugely developed as of now.
Not too much study has been done on the market where the citizen himself creates a corpus and pays a pension to himself through a systematic withdrawal. One can have some references to the 4% rule that is basically a US-based rule, which has no relevance to India at all but is an extremely powerful way in which you can provide for yourself - because people are now living for 30-35 years beyond retirement. When you live for that long, you will be needing money and for that long, you cannot afford to lock in your entire amount in a fixed income because that will not beat inflation and you need to beat inflation after taxes.
The only product that can do that for you is equity and how to include that and how to benefit from a self systematic withdrawal strategy is what we should be discussing today.
Now you are saying that the annuity market is really not very well developed. How can SWP be used over years so that the entire phase post retirement one can have a regular income? How can we work around this particular strategy keeping taxes in mind and keeping the requirement of you regular income in mind?
For the first part, a lot of work has been done. The accumulation phase is well covered. Coming to the systematic withdrawal plan phase, there is a self-balancing balanced fund. Right from 1979, the Sensex data is available. We have also picked up fixed income data from 1979 to 2005 and extrapolated it into a liquid fund.
So effectively we have data both for fixed income and for equity markets going back from 1979 till 2022. Now let us say somebody had one crore corpus, how much can he withdraw if he needs to withdraw for 30 years so that the corpus does not run out? How to determine that? So based on past performance, we have determined that if out of your corpus, 80% is put in the BSE Sensex and 20% in a liquid fund, past data show that if you had started your withdrawal from a Rs 1 crore corpus at Rs 27,300, that money would have to keep increasing because of inflation. That is the issue with annuity.
In the annuity market, the amount remains fixed and so at the starting, it might be a decent amount but as the years go by, the value of that money reduces. In this, we are assuming that your withdrawal will go up by 6% every year and this is also after taking into account a 10% capital gains tax. So, if you withdraw Rs 27,300 in the first year, Rs 29,000 in the second year, Rs 30,700 in the third and so on, for 30 years you keep increasing it 6% every year that one crore will have lasted you for the entire 30 years.
Now if you were to take a little more risk and say that I am okay if it sort of runs out, then that number, instead of starting at Rs 27,300 jumps up to Rs 47,100. That money you can withdraw and please remember that is also inflation indexed. So the Rs 47,000 will become Rs 50,000 in the second year, will become 53,000 in the third year and so on. This is a very powerful strategy to get an inflation indexed pension because a self-balancing fund is both a tax friendly measure because the balancing happens inside the fund and when you withdraw, only the gains portion is taxed. So, iIt is so tax friendly. A disclosure is that these workings are based on a lot of assumptions and obviously the biggest disclosure that is required is that past performance does not always repeat in the future.
When we are withdrawing the money, the corpus is invested in what kind of a fund or in what kind of an investment instrument? It is not compounding anymore?
Correct. What is assumed is the corpus is 80% in a Sensex index fund and 20% in a liquid fund but in a fund where it is constantly being kept at that level at 80 and 20. So, assuming you started out with Rs 1 crore and Rs 80 lakh was put in BSE Sensex and Rs 20 lakh in liquid fund, but in a fund of funds.
So if the Sensex rises, then they would have to sell off the Sensex and buy the liquid. If the Sensex falls, they will have to sell the liquid and buy the Sensex. These all assumptions have been taken in this working on the past data and after that these withdrawal assumptions have been taken. These calculations are based on Sensex data and it is assumed investing 80% in Sensex linked fund and 20% in liquid fund. where they automatically keep rebalancing it every month.
Here we are considering post retirement phase, but for anyone who wants to go for early retirement at the age of 40 or 45, how can SWP be helpful?
SWP may not really help the people who want to retire early because they would have intermittent incomes. They have not really retired in the sense they are doing what they want to do. They are not working for money, that is my assumption, in which case, they are not sure how much they would want to withdraw every month.
It would depend on whether there is a shortfall in their income. The normal idea is that the corpus that is accumulated can continue to grow and their current expenses will be met out of current incomes. Now they do not need to accumulate more corpus. That is the general understanding. They need to withdraw from the corpus only in case of an emergency. If the current income does not come through at all or is not, even equal to the living expenses, there has to be case to case calculations. I do not think systematic withdrawal would help those people.
