We spend a good part of our working lives, planning for what’s in store when we retire. If the planning has been disciplined, chances are that there is an accumulated lump sum in more than one asset to see you through the retirement years.
Discipline with our money habits is something we need even post-retirement. Without this, the accumulated lump sum can get spent a lot sooner than expected.
One way to avoid overspending the carefully saved and accumulated retirement kitty is to build an adequate stream of regular income with the accumulated amount.
The good news is that there is more than one way to do this.
National Pension Scheme
Investing in the National Pension Scheme (NPS) is an automatic way to build a regular income stream. The product structure has an annuity or a regular payout built-in after maturity.
Assume that you keep the NPS investment till maturity or till you become 60 years old, whichever comes earlier.
You can convert at least 40% of the corpus into an annuity and withdraw up to 60% of the corpus. The annuity amount then becomes your regular income.
If this is not enough on a monthly basis, you can reinvest the 60% withdrawn as a lump sum in the ways illustrated in the points below to create an additional source of regular income.
While the amount received as the annuity is not taxed, 40% of the lump sum received will be taxed at your marginal rate of income tax.
The contributions you make now into the NPS account will determine the size of this corpus at retirement.
Shifting the corpus to low-risk investments
Ideally, a bulk of your retirement funds should be in long term investments like equity. They can be either direct or through managed funds.
As you get closer to retirement, shift some of this accumulated pool to low risk, transparent and liquid securities like debt and money market mutual funds or even bank deposits.
- Firstly, estimate your monthly income requirements. Calculate what you will need at this rate for the next 60 months or five years and withdraw that amount to shift to a low-risk investment.
- If you are moving this to bank deposits, then creating a savings cum fixed deposit account or sweep account may be useful. If you choose to invest in debt mutual funds, have a selection of liquid and short-term income funds.
- Keep the money you need for the next two years in liquid funds and the rest in short term income funds with an average maturity of not more than 2 years. While liquid funds are not really meant for two-year parking of money, this choice caters to the need for high safety.
- Set up an automated monthly withdrawal from the liquid fund for the next two years for your monthly requirement.
Any shifts out of mutual funds, including for monthly withdrawals, will be subject to long term capital gains tax.
Setting up a systematic withdrawal from equity
The idea of shifting investments from long term portfolios made with equity assets into debt assets (partially or otherwise) is to ensure one thing.
That one thing is that the funds you need in the next three to five years are secure and at minimum risk.
However, this shift is required only if your equity assets are less than adequate at the time of retirement. Less than adequate can be qualified by doing a stress test and implement as described below.
- Take the value of your entire portfolio and reduce it by 60%.
- Then divide the remaining amount to see how many months’ worth of expenses you can derive from this corpus.
- Lastly, reduce the estimated amount for additional expenses of travel and emergencies. Then, see how many months the corpus can cater to. Is this remaining corpus is sufficient for the next 5-6 years’ expenses? If yes, then you can continue to remain invested in equity.
- Create a systematic withdrawal plan for the amount you need each month from this corpus.
- Use that as your regular income. To reduce some risk, you can move the bulk of the investment into large-cap or index-based funds.
This is still a high-risk retirement income strategy. This is perhaps best considered if there is a supplementary pension income from some other source or rental income coming in addition.
Retirement is a time of change and new beginnings; you mustn’t take your financial life for granted. Plan ahead and ensure that regular income is secured beforehand.
Whether it's planning for a retirement corpus or implementing a stable and secure way to invest in equity, we at Scripbox are here to help.