Why Systematic Withdrawal Plans are best for your Retirement Planning?

You may spend several years of your life saving for retirement. Now, imagine you have reached that stage, and your life savings and investments are at your disposal. This can be a substantial sum, and managing it wisely is important to ensure financial security throughout your retirement years. You will likely have two challenges here. You need to cover your expenses for life while also ensuring your money continues to grow to keep up with inflation. A Systematic Withdrawal Plan (SWP) in mutual funds (MFs) can help you here. It allows you to withdraw a fixed amount periodically while potentially keeping the rest of your investment growing. Let’s find out more about it. 

How does a Systematic Withdrawal Plan work? 

An SWP in MF lets you withdraw money from your mutual fund investments in a structured manner. It ensures you receive a regular income at your chosen frequency while keeping the remaining funds invested in the scheme for potential growth. 

Here’s how it works:

You can invest in a mutual fund of your choice. When you retire and need regular income, you can set a fixed withdrawal amount and choose how often you want to receive it - monthly, quarterly, or annually, based on your financial needs. While you withdraw a portion of your investment at regular intervals, the remaining funds stay invested. This gives them an opportunity to generate returns over time, based on market performance. Well-performing investments can help combat inflation and ensure your savings last longer. 

Here’s an example to understand this better:

Suppose you have invested in a mutual fund scheme and decide to set up an SWP to receive ₹50,000 every month in retirement. The withdrawals are made by redeeming units of your mutual fund holdings based on its current Net Asset Value (NAV). For instance, if the NAV of the mutual fund is ₹10 at the time of withdrawal, the fund will redeem 5,000 units (₹50,000 ÷ ₹10) to generate the required amount. The remaining units will stay invested in the market.

Since the NAV fluctuates over time, the number of units redeemed each month may vary. If the NAV rises, fewer units will be redeemed. Conversely, if the NAV falls, more units will be redeemed. However, the SWP withdrawal amount will remain fixed at ₹50,000. 

Benefits of using an SWP for retirement planning 

Here are some benefits of opting for an SWP for retirement planning:

• It can provide regular income throughout retirement: An SWP ensures a steady cash flow to cover essential and non-essential expenses in retirement. You can also increase or decrease the withdrawal amount and choose the frequency of withdrawals as per your requirements. This makes it an effective strategy to mimic your pre-retirement income and provide you with financial stability.
• It allows the rest of your money to grow: One of the key reasons an SWP is a suitable option for retirement planning is that it ensures your money does not sit idle, unlike a traditional savings account. While you withdraw a portion of your investment at regular intervals, the remaining amount stays invested in the market. This helps you maintain financial liquidity and, at the same time, gives you an opportunity to earn returns. 
• It offers protection against inflation: The portion of your money that remains invested in the mutual fund scheme has the potential to earn market-linked returns. This can help counteract the effects of inflation.

How do SWPs provide steady income post-retirement? 

SWPs ensure a regular flow of income in retirement, which helps you maintain financial liquidity without having to manage a large lump sum. Instead of making sporadic withdrawals here and there, an SWP allows you to receive a fixed amount at your chosen frequency. This ensures financial discipline and helps you effectively plan for your retirement needs.

This structured approach prevents overspending while also eliminating the fear of running out of funds too soon. You can calculate a suitable withdrawal amount based on your total investment and expected expenses. Once an SWP has been set up, the chosen amount is credited to your account periodically. You can use this money to cover essential costs like groceries, medical bills, transport, and other day-to-day expenses. 

Moreover, you can alter the SWP amount based on your life stage and other factors. You can increase the withdrawal amount if your medical expenses rise as you age. You can also decrease it if you wish to preserve more wealth for your future generations.

Tax efficiency of SWPs

SWPs offer a tax-efficient way to withdraw your funds compared to lump-sum withdrawals. When you withdraw a large sum at once, the entire amount can be subject to tax, resulting in a higher tax liability. Spreading your withdrawals over multiple years can help you manage taxes more efficiently. 

SWPs versus other retirement income options 

While there are multiple ways to generate income in retirement, SWPs can offer a unique blend of flexibility and potential for growth, which makes them suitable for diverse retirement needs. 

For example, retirement tools like Fixed Deposits (FDs) can provide lower risk and guaranteed returns in retirement. However, the returns may be lower compared to mutual funds, and they may not always keep pace with inflation. Annuities can be another popular retirement investment option. They offer guaranteed, regular income for life. However, standard annuities, too, may lack the inflation protection that market-linked investments like mutual funds can provide.

It is important to evaluate different options and select the one that aligns best with your retirement needs.

Key considerations before opting for an SWP

Here are some things to consider before opting for an SWP:

• Select a suitable amount based on your needs: Assess the amount of money you need each month to cover your recurring and non-recurring expenses.
• Understand the impact of NAV on your withdrawals and remaining investment: Since withdrawals are based on the NAV of the mutual fund, market fluctuations can impact the number of units deducted from your investment. It is important to factor this into your SWP.
• Consider your age and life expectancy: Your withdrawal strategy should align with your age and expected lifespan to ensure you do not outlive your savings.

Conclusion

SWPs for retirement can be a suitable strategy to maintain a regular income while allowing the remaining investment to potentially grow and counter inflation. However, assessing your financial needs, age, and market conditions is important while opting for an SWP.