You have worked hard to build your retirement corpus. Now you want to plan your SWP and make your savings last. Use this calculator to find out how long the money will last!
Note: Withdrawals assumed at the beginning of the year. Returns added at the end of the year.
What is a Systematic withdrawal plan?
For those who aren’t in the know, a quick explanation of what an SWP is first. If you know, skip this section!
The purpose of an SWP is to ensure that you have a regular flow of income to meet expenses by automatically withdrawing an amount from your investment each month (or any other periodicity).
So, if you have say, Rs 10 lakh in a fund, you can set up an SWP to withdraw Rs 10,000 every month. The fund will redeem units equivalent to this Rs 10,000 and pay the amount out to you.
Why do an SWP? Tax efficiency!
Essentially, the benefits of an SWP are as follows:
- One, you wind up paying lower tax on the withdrawn amount than you would if the same amount came to you in the form of fixed deposit interest.
- Two, an SWP is more flexible as it allows you to change the monthly withdrawal to suit your requirements – you can go higher if needed or lower. It is hard to do so in a fixed deposit. It’s also easier to tap into to withdraw a higher amount to meet any sudden large expense.
- Three, it is a far better substitute to dividend pay-out option of mutual funds. You decide how much you want as income every month and not leave it to the AMC to declare what it wishes to. It is far superior in terms of taxation as we will see further below. Note that dividends are entirely taxed in your hands effective April 1, 2020.
SWPs can be done from any fund but is best done from a low-volatile asset class – like a debt fund – for income generation. When you withdraw, you pay tax on the capital gain – i.e., the difference between your purchase price and redemption price. If the holding period is less than 3 years, this capital gain is taxed at your slab rate. For longer holding period, gain is taxed at 20% with indexation benefit.
What should the SWP amount be? Keep it reasonable!
When you want to set up an SWP, the key is the rate of withdrawal. Many of you want your corpus to stay intact or at least not deplete soon.
The withdrawal rate needs to be in line with the approximate return you can get from the debt fund.
If so, the rate of withdrawal should be such that it does not deplete the capital quickly and allows the returns to compound. This ensures that the corpus last longer. Too low a rate will simply leave you short of income.
The withdrawal rate needs to be in line with the approximate return you can get from the debt fund. Typically, short-term and corporate bond funds have delivered average 3-year returns of 7.8% in the past 8-year period. Ultra short and similar funds delivered an average 1-year return of 7.5%. A slightly lower approximation of these can be taken as the withdrawal rate, which works out to 6-7% a year. You can withdraw lesser, but going higher than this rate is not the best idea.
Where should you invest? Low volatile only
When you need to make steady withdrawals:
- One, you cannot take the risk that your fund could see big losses or prolonged underperformance. This takes any equity and equity-oriented fund out of the picture. While your corpus can have equity (as we discussed last week), shift it to debt before you need to access the amount for SWP. Also barred are credit risk funds and any other debt fund that holds low-credit papers.
- Two, you cannot afford your fund to have return fluctuations. Volatility in returns means that you may wind up redeeming on losses or that your investment is not going grow steady enough for you to comfortably withdraw from.
Low volatile debt categories are usually those that earn returns through accrual. These funds are the most suitable for SWP purposes.
- Liquid funds and ultra short/low duration/ money market funds are the most suited for SWP. The bulk of your SWP portfolio (at least 60-70%) should be in these funds, as the aim is to have steady and safe returns.
- The liquid category is one that offers the steadiest returns, especially in short-term periods of 1 year and lower and are low risk as well.
- Ultra short and similar categories can generate losses in 1/3 month timeframes and therefore better suited for SWP after say, 6 months to 1 year of holding. But as some funds in this category carry credit risk, check to make sure that you’re not inadvertently taking on risk.
- For other accrual categories such as short duration, banking & PSU debt, or corporate bond, keep investments to a third of the portfolio. These funds can pep up your SWP portfolio returns. But start withdrawing only after completing 2-3 years of holding as these funds need this period for optimum returns. Ensure that you’re not taking credit risk here, either.
- Dynamic bond funds are best avoided. They switch between duration and accrual and this pushes the category’s volatility higher. Not only that, a wrong interest rate call can wipe out returns built up.
- Gilt funds are also volatile given that gilt prices fluctuate based on interest rates. However, if you do want to hold gilt funds because of their low credit risk, you will have to allow at least 5-7 years before you can begin withdrawing from them.
What an SWP is not
An SWP does not necessarily mean that your capital will stay intact forever. Based on inflation, your withdrawal and returns you may eventually start drawing down from your capital. Your fund units can go to zero. Maintaining a reasonable withdrawal rate helps push back the time when you draw from the capital and lets your corpus last long enough that you don’t fall short of money. This is unlike an FD, where your principal stays intact.
Make sure you have a diversified income stream with fixed income products such as FD and Senior Citizens Savings Schemes and use SWP as an add-on.
About this SWP calculator
This SWP Calculator enables you to figure out exactly how long your investment corpus will last when you use systematic withdrawal plan to withdraw money from the corpus. It takes four inputs:
- Amount of corpus
- Expected investment returns from the corpus
- Expected rate of inflation during the period of withdrawal
- The monthly withdrawal amount
The expected returns and expected inflation are assumed at 8% and 6% – but you can change them to any reasonable number. The output will tell you how many years you can do the withdrawal before exhausting the corpus.
You can read this detailed article about SWP to get more information.
More information about safe withdrawal rate.