Category: Retirement Planning

Systematic Withdrawal Option: A tax efficient way to ease into retirement

Systematic Withdrawal Option: A tax efficient way of earning retirement inflow benefits.

So, you have accumulated the corpus through sheer hard work, and discipline of savings through your earning years, in the accumulation stage of planning for an inflation adjusted inflow at retirement.
The accumulation stage or the period when one's savings are directed towards various instruments, may include a combination of Mutual funds, Equity, FDs, Rental income, Pension, EPF, PPF, Policies , post office, tax free bonds, Dividend income. These instruments should be channelized towards a corpus to provide for
a) Inflation adjusted monthly income at retirement.
b) Tax free or reduced tax monthly income at retirement.

What most people ignore is the "Distribution Phase" or the period when one rely's on the most tax efficient distribution of accumulated corpus to receive a monthly income.

The objective is to provide for the optimum amount of income without having the burden of tax eating into the real return drawn to meet your golden years.

Systematic Withdrawal Plan (SWP) is a suitable option to plan for a tax efficient monthly inflow.

A SWP option is set up in a corpus, mentioning the amount of monthly withdrawal needed and the duration of need of monthly withdrawal.
Since, the withdrawal is made every month/quarter; it results in the sale of certain number of units. This would create the incidence of capital gains tax due to the withdrawal made.

Withdrawals made before one year lead to short term capital gains tax as per tax slab for debt instruments and 15% plus surcharge capital gains tax on equity instruments.

An example below shows how this option can be utilsed in a fund.

If for example on 1 Jan 2012, you invest Rs 10,00,000 in a debt fund at an NAV of Rs 10
You require a fixed monthly income of Rs 10,000 or Rs 1,20,000 per annum (For the purpose of simplicity we are not assuming the monthly income increases by inflation each year, in the below illustration, which is accounted for in the second illustration)

The withdrawal made per month, results in the sale of some units every month.
If the unit price has increased by 10% at the end of year one(ie Rs 10 has moved to Rs 11 and your average selling price for each withdrawal made in the year was Rs 10.50)

In the whole year you have sold 11428 units/shares (Rs 120000/10.50)

Capital gain is Rs 5715 (0.50 per unit*11428 units)
The Capital gains tax is Rs 1714.50(assuming hightest tax bracket of 30% minus surcharge)

Your total withdrawals made were Rs 120000 and you have paid a tax of Rs 1714.50 only for the whole year.

This rate will further reduce, after one year when the capital gains tax on equity falls to NIL and on debt at 10% flat or 20% after indexation (WIL)

In a second illustration, if you invest Rs 10,00,000 in a debt fund at Rs 10 per unit giving you 1,00,000 units.
Assuming you need the same Rs 10000per month or Rs 1,20,000 per annum growing by 5% per year, and the balance corpus grows at a modest 5% per annum after withdrawals, and there is a tax of 10% on the capital gains made every year(30% in the first year), from the withdrawal of certain number of units, the corpus will last more than 27 years and the IRR is 8% post tax!

This is a tax efficient method of withdrawing from a corpus and providing for a balance available for Estate Planning also.

So now you know what to ask your financial planner to plan for, when you retire!

(Contributed by Dilshad Billimoria BBM LUTCF CFPCM)

27 June 2012