Category: Investment Management

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

Retirement planning is one of the most important activities of an advisor. The ‘accumulation’ stage while building up a retirement corpus is the period when savings are directed towards various instruments, which may include a combination of mutual funds, equity, FDs, rental income, pension, EPF, PPF, policies, post-office savings, tax-free bonds and dividend income.


These instruments should provide for:


Inflation-adjusted monthly income at retirement.

Tax-free or tax-efficient monthly income at retirement.

Keep in mind that most people ignore the ‘distribution phase’ or the period when one relies on the most tax-efficient distribution of accumulated corpus to receive a monthly income.


Your objective should be to provide for the optimum amount of income that a client can receive without having the burden of tax eating into the real return needed for his golden years. Recommending a Systematic Withdrawal Plan (SWP) is a great option for a tax-efficient monthly inflow.


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


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


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


Let us say, on 1 Jan 2012, your client invests Rs 10,00,000 in a debt fund at an NAV of Rs 10.


The requirement is a fixed monthly income of Rs 10,000 or Rs 1,20,000 per annum. The withdrawal made per month results in the sale of some units every month.


Consider that the unit price has increased by 10% at the end of the first year (i.e., Rs 10 has moved to Rs 11 and average selling price for each withdrawal made in the year was Rs 10.50).


In the whole year, the investor would have sold 11,428 units/shares (Rs 1,20,000/10.50).


Capital gains is Rs 5,715 (0.50 per unit*11,428 units).


The capital gains tax is Rs 1,714.50 (assuming highest tax bracket of 30% minus surcharge).


Total withdrawals made were Rs 1,20,000 and tax paid is only Rs 1,714.50 for the whole year.


This rate will further drop after one year when the capital gains tax on equity falls to nil and on debt at 10% flat or 20% after indexation.


In the second illustration, let’s say the investment is Rs 10,00,000 in a debt fund at Rs 10 per unit giving the investor 1,00,000 units.


Assuming your client needs the same Rs 10,000 per 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.


(Dilshad Billimoria is a BBM, LUTCF CFPCM, Certified Financial Planner and Investment Advisor)


16 May 2012