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How to mix an SWP from an equity mutual fund with a pension plan in retirement?

This article shows how much you can withdraw from an equity mutual fund if you have a pension plan as well in retirement.

How to mix an SWP from an equity mutual fund with a pension plan in retirement?


Posted on 09 Oct 2022
Author: Sayan Sircar
12 mins read
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This article shows how much you can withdraw from an equity mutual fund if you have a pension plan as well in retirement.

How to mix an SWP from equity mutual fund with a pension plan in retirement?

📚 Topics covered:

This article is a part of our detailed article series on Safe Withdrawal Rates. Ensure you have read the other parts here:

Who would have a pension plus mutual fund portfolio?

One good example is NPS investors who will need to utilize at least 40% of their NPS corpus as an annuity when they withdraw at 60. The remaining NPS corpus may be invested in any product of choice.

Another example of such portfolios belongs to investors who have:

  • purchased deferred annuities when they were earning income before retirement
  • have voluntarily decided to purchase an annuity either at the start or at the end of retirement
  • have received a windfall from a property or other sale or inheritance and have decided to safeguard that corpus via an annuity purchase

We will consider below an investor who has decided to invest 40% of their retirement corpus at age 60 into a 5%/year annuity taxable at 30%, while the remaining 60% of the portfolio is invested into an equity index fund.

The annuity will fund a part of the monthly expenses while the rest will come out of the equity mutual fund via SWP. Due to the lack of data for the Indian market, we use Monte Carlo simulation using Nifty 50 Total returns index data since 1999 to model 1,000 retirement paths for SWR ranging from 1% to 5% at 0.5% intervals.

Defining SIP, SWP and STP

SIP SWP and STP

All of these are standing instructions that get executed as per a schedule you specify:

  • Systematic Investment Plan (SIP): Money from a bank account is invested into a mutual fund, typically once a month
  • Systematic Transfer Plan (SIP): Units from a mutual fund are redeemed to invest in another mutual fund of the same AMC
  • Systematic Withdrawal Plan (SWP): This is the reverse of the SIP. You sell the units from a mutual fund to send money to a bank account

In this article, we will see if you can have an SWP during retirement to fund in-retirement expenses and see what happens if there is a pension plan. Here the success criterion is:

  • being able to keep up with inflation. We will assume 7% inflation during retirement. At this rate, costs double in around ten years.
  • not to run out of money before dying. We will assume 30 years in retirement

There is a caveat that the pension plan will continue to pay throughout retirement, until the day you die, even if the equity corpus goes down to zero.

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What is the effect of having a pension plan in retirement?

Pension during retirement

As we see in the diagram, the blue part is the retirement corpus that first rises and then falls. The red dashed line is the pension income that becomes a floor value for income in retirement. No matter how much the rest of the corpus fluctuates, the income does not go down to zero. However, due to inflation and tax, the value of the pension may not be much. If we assume a 7% inflation rate, the value of a ₹50,000/month pension, which requires an investment of ₹1.4 crores approximately at 5% returns and a 15% effective tax rate,

  • ₹50,000/month in Year 1
  • ₹25,000/month in Year 11 (purchasing power cut by half due to 7% inflation)
  • ₹12,500/month in Year 21 (purchasing power cut by half again)
  • and so on

Therefore, even when the starting value is decent, the purchasing power of the annuity drops rapidly with time.

Sample portfolios - 4% SWR / 25x expenses

We will assume that the first year’s withdrawal to be a value between 1% and 5%. The withdrawal amount will be increased by inflation every year. As a practical example, we will take

  • starting portfolio of one crore with 40% in an annuity (3.5% return post-tax) and 60% in equity index fund
  • ₹2.5 lakhs expense in year one; 2.5 * 1.07 = ₹2.675 lakhs expense in year two etc.
  • the annuity funds 3.5% of 40 lakhs / 12 = ₹11,667 per month for life. This is purchased as a fixed annuity with a joint payout that runs until the death of the last spouse
  • since SWP is a standing instruction, we will edit the withdrawal amount in the mutual fund portal once a year to adjust for inflation
Start ₹ 1,00,00,000 Net withdrawal from MF
Withdrawals ⬇️
Year 1 ₹ 2,50,000 - ₹ 1,40,000 ₹1,10,000
Year 2 ₹ 2,67,500 - ₹ 1,40,000 ₹1,27,500
Year 3 ₹ 2,86,225 - ₹ 1,40,000 ₹1,46,225
Year 4 ₹ 3,06,261 - ₹ 1,40,000 ₹1,66,261
Year 5 ₹ 3,27,699 - ₹ 1,40,000 ₹1,87,699

We define “success” as ending with a non-zero portfolio, i.e. not running out of money, after a 30-year retirement with an SWR between 1% and 5%. As per the definition of SWR, the starting portfolio value is 1/SWR. So in terms of the first year’s expenses, a 4% SWR is 1/4% = 25x expenses.

Example: success case

This case leaves behind a ₹4 crores corpus for the heirs.

(click to open in a new tab)
SWP from Index fund and pension for Retirement using the Nifty 50 TRI - Success case

Example: failure case

This case runs out of money around 3/4th time into retirement.

(click to open in a new tab)
SWP from Index fund and pension for Retirement in the Nifty 50 TRI - failure case

However, given that the pension is active, the family continues to earn ₹140,000/year as a pension.

Also read
What is a Personal Accident Insurance policy: who needs it and why?

Results

We run 1,000 such simulations for each of the SWRs and calculate the number of cases where there is a non-zero portfolio value after 30 years.

(click to open in a new tab)
SWP from Index fund and pension for Retirement in the Nifty 50 TRI

Here the “Nearly failed” case is equal to an ending value less than or equal to one-fourth of the starting value. Since the starting portfolio is ₹1 crore, any ending value less than ₹25 lakhs is a near-miss. At 7% inflation, this ₹25 lakhs has lost its purchasing power to just ₹3.2 lakhs in 30 years and will, depending on the SWR, pay for only a few months to a year of retirement expense in the 31st year.

We also compare against the same simulation with the same data but with 100% of the portfolio in the Nifty 50 index fund as described in this article: What happens if you do an SWP from an index fund in retirement?.

(click to open in a new tab)
SWP from Index fund and pension for Retirement in the Nifty 50 TRI comparison

The conclusion is quite clear:

  • adding a pension plan dramatically lowers the chances of completing retirement
  • the gap vs equity only portfolio lowers at lower SWRs but at such low SWR levels, there is enough wealth to make the investor ambivalent about the choices

If you are investing a lot in NPS for retirement, ensure that you accumulate enough to reach the stage when the SWR is low enough. If it is not, you will reach an unenviable position when you are forced to take the annuity and that makes it even less likely to complete retirement successfully.

Is there a way to take an SWP from equity but yet get guaranteed income via pension?

The following article takes a different approach. Instead of a fixed percentage SWP, it implements a variable one equal to the dividend yield of the equity portfolio and uses those dividends to buy a pension plan every year.

How to get guaranteed income in retirement by combining dividends and pension?

Caveats regarding the analysis

  • we have assumed that the next 30 years behave like the previous 30. Any changes in how the relative risk and returns of the stock market will change the result considerably
  • the Monte Carlo simulation assumes that the returns follow a Normal distribution where falls are just as likely as rises in the market. In the real stock market, falls are more frequent or further than rises
  • we have assumed that the annuity returns 5% pre-tax. As India matures as an economy, we will expect annuity returns to lower further. This interest rate fall will make purchasing an annuity a worse proposition

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