Planning for the Golden Age – Retirement – Part 4

Best and recommended option for investing the retirement corpus which can significantly save taxes

This is the final chapter in the retirement planning module. Set to be an interesting read as many of the retired individuals are looking for the best investment option given the current low interest rates in fixed deposits and other instruments. Also, paying higher taxes is something which all of us are not comfortable with, so, in this article, we will be covering about how to reduce the taxes as well.

If you are choosing an instrument from the list of top preferred retirement solution products, (given in the previous chapter, you can go through it by clicking here), you must keep in mind that the returns you get are taxable in your hands.

Since most of us are likely to be in the 30% tax slab even after the retirement, we end up paying higher taxes. That is where SWP (Systematic Withdrawal Plan) comes into play.

In this chapter, we will be looking at ‘How SWP works and how much of taxes can be saved compared to other fixed income products such as fixed deposits & more importantly, how Strategic SWP works’.

Here we go:

First thing first, What is SWP and how it works:

Since most of us are salaried employees, we are used to the regular flow of monthly income till we retire. But there comes a time when you start depending on X factor for such needs. Most probably the X factor is your savings and investments.

SWP is an option which allows you to withdraw a fixed amount from your mutual fund investments. You will be allowed to choose the amount, the frequency and the duration of the SWP.

Since you will be given an option to decide on the withdrawal amount and frequency, it satisfies the need for having a regular income. Infact, to the tune of the inflation, you can change the SWP amount at a certain frequency (for example, yearly increase in withdrawal amount by 5%). Thus, your inflated expenses will also get covered.

How it works:

Deploying the money in mutual funds (say in debt funds) and set-up the SWP. SWP are available at various frequencies monthly, quarterly etc. The scheme will sell the respective units at the frequency you choose to the tune of the amount you require and gets credited in your account.

To give you an illustration,

* Interest Rate as per the SBI deposit rates from sbibank page

** Considered Axis liquid fund for making the analysis.

Whenever the units get sold, there is a capital and gain in it and you pay tax only on the gain against instruments unlike Fixed deposit where you get only the interest payment and the entire amount is taxed. Thus, the tax payable on these products differ significantly.

 Interesting, right?  

BUT,

Since the withdrawal amount is decided by the investors, there can be situation where if the quantum of withdrawal is high (more than the return percentage), the capital can take a hit.

Especially, given the fact that your monthly requirement amount will keep increasing due to the tune of inflation, JUST A PLAIN SWP may not work for everyone.

So, that is where, an expert advice comes to rescue.

Since there is a scope of investors losing capital if the required amount increases, we need to adapt Strategic SWP.

I would like to walk you through, how Strategic SWP works through a case study.

Case Study:

Mr.A is a retired person wants to deploy his retirement corpus of Rs.1 crore and he is 60 years old and wants to plan for the rest of his life. Life expectancy is 85 years. He wants to know which is the best instrument to invest in which can give him a regular amount considering the inflation @ 5% p.a and a starting monthly inflow of Rs.50000. He wants an investment proposal with tax efficiency.

Solution:

Workings:

 Summary:

• Over the course of 25 years, (if the same tax rates are applicable), the tax outgo is around 16 lakhs.
• A would have withdrawn close 2.87 crores.

Remaining Amount would have got invested in Equity Funds and here is how it would have delivered.

 Summary of equity funds:

• Equity funds are not expected to grow on an even basis, however, history says that 5 years rolling returns of equity funds have always delivered double digit return (atleast 12%) and that’s why the assumption was 12% in equity funds.
• Allow the equity funds to grow and when there is a requirement in debt fund, switch the amount from equity to debt.
• On top of all this, Mr.A in this case, would have ended up with around 45 lakhs by the end of 25^th year from his retirement.

Outcome of the case study:

So, a wise-planning can get the best of your investments and at the same time, will be tax efficient too. The following table briefs you the benefits you could have by investing through SWP compared with Fixed deposits.

* Now, one may argue that in fixed deposit the capital remains intact and in strategic, there is possibility of capital getting eroded.

Well, the below chart will explain it:

*Assumed that interest rate remains the same throughout the period of 25 years. However, if you have gone through the previous chapter, you will understand that there is always a reinvestment risk in fixed deposit and rates are coming down in the last ten years and the trend may continue.

**Considered, 6% for debt funds (to compare it with fixed deposit), however, in the last one-year, three-year, five-year returns have all delivered little more than 6% (this is as on 30^th June 2021)

***For Equity funds, the assumed rate of return is 12%, in the last 20 years, the rolling return of any 5 years have always delivered positive double-digit return and we have considered 12% in the case study which the five years returns have outperformed comprehensively.

**This is as per current tax-slab rates.

So, a conservative approach in strategic SWP can get you a significant difference in the overall corpus.