You work hard all your life and save to ensure you have a financially secure retirement. Now, after decades of saving, it is time to start spending once you retire. You shift from the accumulation to the spending stage, and hence, you should be careful when withdrawing retirement fund. The objective is to create a withdrawal plan that is sufficient to cover your expenses and also ensure that you do not outlive your retirement savings in the long run.
Your retirement fund is your corpus for the golden years of your life. You have no source of income during those years, and your retirement fund is your only support. As a wise planner, you must structure your retirement withdrawals in a manner that you have sufficient funds for all your life. This becomes even more critical as your longevity increases, requiring you to save more sum for your retired years.
If you withdraw too much, you risk running out of your retirement fund sooner. However, if you withdraw too little, you might be able to fulfil your retirement goals. A good way to create a reliable source of income is by investing in an annuity plan.
Annuity plans give you a regular payout for life (inclusive of returns) after you make a lump sum investment. But overall, you must maintain a sustainable withdrawal rate so that you can live well all through your life.
How much should you withdraw from your retirement fund?
A major component of your retirement plan is to withdraw wisely each year without running the risk of outliving your money. Given the lesser interest rates, market volatility, and COVID-19 job concerns, fears of running out of money during retirement have become very real.
One frequently used rule of thumb suggested by experts for adequately withdrawing retirement fund is the 4% rule. As per this 4% rule, you add up all your sources of income and investments and withdraw 4% of that total in the first year of your retirement. In the following years, you adjust your retirement fund withdrawal to account for inflation. By this rule, you have a high probability of not outliving your retirement fund during a 30-year long retirement.
For instance, your total retirement income totals Rs. 1 crore. Going by the 4% rule of withdrawing retirement fund, you can take Rs. 4 Lakh during the first year of your retirement. However, if the cost of living or the general price index rises by 2% in that year, you can give yourself a raise of 2% in the following year.
This means that in the second year of retirement, you can withdraw Rs. 4,08,000. In the third year, you can withdraw Rs. 4,16,160 (second-year amount + inflation of 2%), and so on for the next 30 years of your retirement.
Is the 4% rule still relevant for retirees today?
The 4% withdrawal retirement fund rule assumes that you only withdraw the defined amount from your retirement fund each year, adjusted for inflation. The rule was conceived in 1994, but the investment world of 2020 has significantly transformed since then.
While the 4% withdrawing retirement fund strategy is a good base to start with, it does not fit all types of retirees. A few caveats:
The rule assumes your spending increases by a constant rate each year and not how your investment portfolio performs. As per this rule, you never spend more or less than the increase in inflation, whereas, in reality, your retirement expenses might easily change from one year to another.
Specific portfolio composition:
The 4% withdrawal rule applies to a hypothetical portfolio comprising 50% stocks and 50% bonds. However, in reality, as a wise investor, you might prefer having a more diversified portfolio and decreased exposure to stocks as you transition through retirement.
Assumes a 30-year period:
As per your retirement age, the 30-year time horizon might not be needed or likely. You could end up living longer than this period, or your retirement could be for a shorter horizon, leading you to either outliving your retirement fund or having an excess of it.
Even though this rule has been a longstanding retirement strategy, most retirees follow it because it offers a predictable amount of income each year. However, there are many drawbacks to the 4% rule, which make it not the ideal strategy for withdrawing retirement fund. Instead, if you favour the 4% withdrawal rule because of this predictable income advantage, then it is wiser for you to invest in an annuity plan.
Annuity Plans: The Perfect Avenue for Retirement Financial Planning
Annuity plans give you a regular and defined income payout during your retirement in return for your lump sum investment made during the working years of your life. You can opt for deferred or immediate life annuity options.
Annuity plans give you the peace of mind and financial security that even during retirement, you have a stable source of monthly earning. In case of an emergency, you can also avail of a loan against your annuity plan. You also have the flexibility to choose your annuity payout mode.
Further, you also benefit from the annuity plan taxation*. The lump-sum you invest in an annuity plan is exempt from tax* under Section 80CCC of the Income Tax Act, 1961. However, the income you receive from your annuity plan is taxable* as ordinary income. But since during retirement, your income gradually reduces, and an annual income of Rs 5 Lakh is essentially tax-free*; this means that you are likely to have zero tax* liability. Further, this implies that if you rely on an annuity to cover a major part of your retirement expenses, your retirement fund withdrawal tax* will be minimal.
If you want to have a failproof retirement plan that assures a financially secure retirement, invest in an annuity plan.