Pradeep Kumar has just embarked on his financial plan. He is 30 years old and wants to save adequately for his later years after he retires at the age of 55. His big challenge is how to pay for retirement? In short, he has around 25 years to accumulate a sizable corpus. His financial advisor has counselled him that his focus must be on equity funds. However, the advisor has also told him that he should structure his payouts in the form of an SWP after his retirement. That would not only ensure higher payouts on a monthly basis for him but also be more tax efficient. Pradeep is keen to understand which are the best between SWP and dividend payout options? He is also not too clear on the advantages of SWP...
How much corpus can Pradeep get at the end of 25 years?
ParticularsBalanced Fund (12%)Equity Fund (14%)Thematic fund (17%)Monthly InvestmentRs.10,000Rs.10,000Rs.10,000Expected Yield Annually12%14%16%Risk over 30 yearsLowMediumHighTotal SIP ValueRs.1.90 croreRs.2.73 croreRs.3.97 crore
While balanced fund may be too conservative for Pradeep, the problem with thematic funds is that they are just too aggressive and too cyclical. That is not what he wants. He wants to create wealth without too much of hassles. His best choice was would be a diversified equity fund which would grow his corpus to approximately Rs.2.73 crore. Whether this corpus will be sufficient or not, will depend on Pradeep’s standard of living after retirement and his commitments at that point of time. So let us make some assumptions about his post retirement expenses.
Some assumptions of Pradeep’s post retirement life style
Pradeep realizes that his expenses are not going to remain static. They will go up along with inflation and perhaps more. For example, some expenses will come down to use the technology and some costs like lifestyle costs will go up over time. He estimates that he would still require around Rs.1.60 lakh every month after retirement to just continue his routine expenses. Raghav believes that the best way would be just put his corpus in a liquid fund and enjoy the benefits. Would that be enough?
Liquid funds generate about 6% annualized returns and when it comes to long term revenue projections, it is always better to err on the side of caution. His corpus of Rs.2.73 crore would translate into yearly earnings of Rs.13.65 lakh or a monthly income of just Rs.1.14 lakh. If he opted for withdrawal via a dividend, then he would straight away lose 29.12% of the dividend in the form of dividend distribution tax (DDT). Remember, DDT is charge at (25% base tax + 12% surcharge + 4% cess). Effectively his monthly post tax earnings will be Rs.80,800. That means he will have to drop his standard of living big time, post retirement. The good news for Pradeep is that, a drop in standard living may not really be necessary. In fact, he can get much better post tax income, if he structures his post-retirement outflows in the form of systematic withdrawal plans (SWP) instead of dividends.
SWP could actually solve all the problems for Pradeep
How will the SWP work? The SWP can be structured in such a way that over a period of next 20 years, the entire corpus is withdrawn s principal + interest. Obviously, you opt for a growth plan and each month you withdraw a fixed amount which will include principal component and capital gains component. Even as you draw down your corpus, your balance corpus continues to earn 5% in the liquid fund. The gain portion will be very small in the initial years so tax will be minimal. As he crosses 3 years, then it becomes LTCG and he has to only pay 20% tax after considering the benefit of indexation. Here is how he can work it out..
YearCorpus in liquid FundAnnual Interest income 5%Annual Withdrawal Closing BalanceYear 1 273,00,000 13,65,00021,90,000 264,75,000Year 2 264,75,000 13,23,75021,90,000 256,08,750Year 3 256,08,750 12,80,43821,90,000 246,99,188Year 4 246,99,188 12,34,95921,90,000 237,44,147Year 5 237,44,147 11,87,20721,90,000 227,41,354Year 6 227,41,354 11,37,06821,90,000 216,88,422Year 7 216,88,422 10,84,42121,90,000 205,82,843Year 8 205,82,843 10,29,14221,90,000 194,21,985Year 9 194,21,985 9,71,09921,90,000 182,03,084Year 10 182,03,084 9,10,15421,90,000 169,23,239Year 11 169,23,239 8,46,16221,90,000 155,79,401Year 12 155,79,401 7,78,97021,90,000 141,68,371Year 13 141,68,371 7,08,41921,90,000 126,86,789Year 14 126,86,789 6,34,33921,90,000 111,31,129Year 15 111,31,129 5,56,55621,90,000 94,97,685Year 16 94,97,685 4,74,88421,90,000 77,82,569Year 17 77,82,569 3,89,12821,90,000 59,81,698Year 18 59,81,698 2,99,08521,90,000 40,90,783Year 19 40,90,783 2,04,53921,90,000 21,05,322Year 20 21,05,322 1,05,26621,90,000 20,588
Pradeep’s corpus will be depleted over 20 years. For simplicity we have shown in yearly format rather than in monthly format. He is able to generate annual income of Rs.21.90 lakh or Rs.1.83 lakh per month. That is nearly Rs.23,000 more than what he requires each month. Even after considering the impact of tax, the surplus can be good enough to create a smart corpus when he turns 75. That is the difference that an SWP can make to Pradeep’s future plan.