Retirement planning: Why systematic withdrawals are as important as SIP investments

We have mixed reactions/emotions the moment we think of retirement. While very few (less than 10 per cent of the population) are adequately prepared for their second innings, most of us start getting sleepless nights on the very thought of how we will manage our expenses for the remaining 20-30 years, when the active income would have come down significantly or even become nil.

Most people start planning for retirement very late in life. Also, many of us have no clue how much corpus is going to be required to fund the biggest goal of our life. Thanks to technology today, we have many resources available online to give us a broad idea on how to plan for retirement. Once we have the clear retirement age and corpus in our mind, the idea is to then choose the right retirement vehicle based on a person’s risk and return profile.

Common retirement investment options

Let's look at the options most of us have for our retirement goals and which ones are preferable to most people. Since there are primarily two phases for the retirement goal – accumulation and distribution. The investment vehicles can be different for different phases. With my interaction with various categories of investors, the following options are most ubiquitous for building retirement corpus – employees' provident fund (EPF), public provident fund (PPF), national pension scheme (NPS), bank fixed deposits (FDs), mutual funds (MFs), equities, etc. For the distribution phase, people use a combination of the following to generate a regular monthly income – pension from the employer, interest from bank FDs, dividend income from equities / mutual funds, rentals, proceeds from endowment / pension policies etc.

The concept of systematic withdrawal plan (SWP) is becoming very popular over the last few years. I firmly believe this is a pathbreaking idea whose time has come. Just like the systematic investment plan (SIP) has been a super hit concept in the previous five years, SWP will become an even bigger idea in the next ten years. An SWP offers greater flexibility in terms of cashflows, and it is highly tax-efficient too. But not too many people in our country are aware of this concept.

Just like an SIP, where we keep investing money every month to create a larger corpus in the future, an SWP can use the same corpus for withdrawing a small sum every month to meet our retirement expenses for the next 20-30 years. Monthly withdrawal from an FD is a kind of SWP too. But in an FD, since we only withdraw the monthly interest that we earn, our principal remains intact. In the case of SWP from a mutual fund scheme, if the monthly withdrawal rate is less than the rate of return we earn, we will end up having a much bigger portfolio in the long term and vice versa too.

For e.g., let us choose an aggressive hybrid equity fund which is one of the oldest fund in the industry and invests around 65-75 percent in equity and the remaining in debt. This kind of fund can be suitable for a moderate risk of investor expecting approximately 10 per cent return over a ten year period. If someone has invested Rs one crore as on 1st January 2000 and withdraws Rs 50,000 per month, i.e. Rs 6 lakhs per annum and keep increasing the withdrawals by 5 percent (of the initial annual withdrawals) to meet up with the rising inflation, then the investor would have withdrawn around Rs 1.88 crore till date (Dec 14, 2020) from 251 monthly instalments. Even after drawing regularly monthly income for the last 20 years, she is sitting on a corpus of Rs 4.64 lakh because her investment has yielded her an annualised return of 12.46 per cent while her withdrawal was at 6 per cent only.

Also read: Need regular income after retirement? Here are some safe investment options

There are multiple advantages of SWP plans as listed below:

-SWP can be done from any Mutual Funds - Be it Debt, Hybrid or Equity

-It can be started from any day. We can choose to invest the lump sum corpus and start SWP from the next day itself.

-You can choose any amount to withdraw from SWP and can also change the amount any number of times in the future.

-It is much more tax-efficient compared to monthly dividends received from Mutual funds for people who are in the highest tax bracket.

-It is entirely flexible. You can withdraw a lump-sum amount also at any point of time.

-You can change the funds or withdraw the entire investment amount also at any point of time.

There is an important caveat though. The returns are not guaranteed. Since the returns are market linked, the investor has to choose the fund according to her risk profile. If markets are going down for a long period of time, the corpus may not last long. In such circumstances, one has to calibrate the monthly withdrawals accordingly. A better idea would be to have withdrawals from a debt fund for the first three years and keep replenishing it at regular intervals by booking profits from the hybrid / equity fund.