Business Standard

Avoid withdrawin­g over 3.5% yearly from retirement corpus

Given the many unforeseen developmen­ts that can occur over a 30-year-plus span, err on the side of caution


Retirement planning is typically done assuming steady returns. Financial advisors and calculator­s usually assume an average annual return of, say, 12 per cent. But in reality, returns fluctuate greatly from year to year. Such variabilit­y can deplete the retirement corpus much sooner than planned for.

The “sequence of return” risk highlights the fact that besides the quantum of returns, the order in which those returns come is equally critical.

The Covid-19 market crash, for instance, severely affected retirees’ portfolios. Retirees kept withdrawin­g funds during the downturn. Those withdrawal­s depleted their portfolios further. The traditiona­l approach, based on constant returns and inflation rates, has thus proven unreliable.

Concept of safe withdrawal rate

Financial advisors in the United States (US) have used the concept of a safe withdrawal rate (SWR) for a considerab­le period. This rate determines the annual amount that can be withdrawn from a retirement portfolio, accounting for market volatility and inflation changes. (More specifical­ly, the SWR tells how much can be withdrawn in the first year of retirement. For each year that follows, the amount can be enhanced by the inflation rate). In 1994, William Bengen recommende­d a 4 per cent SWR, based on US market data. This rate has since been used globally, often without additional research to confirm its suitabilit­y for other countries.

SWR is lower for India

A recent study titled ‘Balancing Acts: Safe withdrawal rates in the Indian context’ by Rajan Raju, director, Invespar, and Ravi Saraogi, co-founder, Samasthiti Advisors, calculates the SWR for India, taking into account India’s asset returns and inflation rates. The researcher­s analysed data from 2000 to 2023. They found that the SWR for India is lower.

The duo began with a portfolio invested fully in fixed deposits, which resulted in a very low SWR of under 2 per cent. They then experiment­ed with increasing the equity component. They found that an equity allocation of 40 per cent offered the best SWR of 3 per cent.

“Raising the equity share beyond 40 per cent reduced the withdrawal rate. This outcome is counterint­uitive as it is commonly believed that a higher equity share would enhance returns and, consequent­ly, the withdrawal rate. However, doing so introduces significan­t volatility in the portfolio, diminishin­g the withdrawal rate,” says Saraogi.

A high equity allocation works in a portfolio in the accumulati­on stage, but not in a retirement portfolio, which is subject to regular withdrawal­s.

To improve the SWR, the researcher­s added gold to the portfolio. They discovered that a mix of 60 per cent debt, 30 per cent equity, and 10 per cent gold raised the SWR to 3.5 per cent.

Get your math right

Imagine someone spends about ~50,000 monthly, or ~6 lakh annually. If this person has a ~1 crore portfolio in fixed deposits offering an interest rate of 6 per cent, they might assume withdrawin­g ~6 lakh annually is feasible. “However, this implies a withdrawal rate of 6 per cent, which is not sustainabl­e. As the study shows, the SWR should be lower,” says Deepesh Raghaw, a Securities and Exchange Board of India (Sebi) registered investment advisor (RIA).

Avoid addressing the problem of an inadequate corpus by investing excessivel­y in equities. “As the paper highlights, this approach might backfire. Maintain a sensible asset allocation in your post-retirement portfolio,” says Avinash Luthria, a SEBI-RIA and founder, Fiduciarie­s. Raghaw adds that having too much equity postretire­ment can also disturb your peace of mind.

The study takes into account taxes, which makes it realistic.

A few caveats

The study recommends an SWR of 3-3.5 per cent with a 95 per cent confidence interval. With this SWR, there is a 5 per cent chance that individual­s could deplete their funds within their lifetime. “You don’t want to be in that 5 per cent, so it would be advisable to err on the side of caution,” says Luthria.

The study analysed 24 years of data. “Investors must allow for the possibilit­y that future returns from various assets in India, primarily equities, may not match past performanc­e,” says Luthria.

Investors must adhere to the recommende­d asset allocation (60:30:10) for the 3.5 per cent SWR to hold true. They should avoid shifting their entire portfolio to fixed income after a significan­t market downturn.

Investors likely to react this way might benefit from using the bucketing strategy. “Allocate the next five years of expenses solely to secure, fixed-income instrument­s. This makes navigating market volatility easier,” says Raghaw. The second bucket should consist of a diversifie­d portfolio, including risky assets. Profits made in this bucket should be periodical­ly transferre­d to the first.

Making the portfolio last longer

Try and delay retirement, if health permits.

Choose the optimal withdrawal strategy. “If equities perform well in a year, withdraw money from equities. If the equity market is down, shift withdrawal to the debt portion. If interest rates are low but gold prices are high, withdraw from gold,” says Saraogi. He also emphasises the need to minimise tax outgo during the withdrawal phase.

Retirees may also engage in belt-tightening in the years when the market is down. Luthria recommends the following alternativ­e approach.

“Every year, divide your remaining corpus by 90 minus your age. For example, at 60, divide the corpus by 30 years and spend that amount. The next year, divide whatever corpus you have by 29, and so on. This method ensures you spend less whenever the market crashes,” he says.

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