A reader asks, “I am aged 60 and have just retired. My total corpus is close to Rs. One Crore, but my monthly expenses are slightly over Rs. 40,000. This means my initial withdrawal rate = annual expenses divided by corpus is about 5%.”
“This is higher than the “old” safe withdrawal rate estimate of 4% and the “new” estimate of 3%. What are my options in such circumstances? Please advise.” See: Why we need to stop using Safe Withdrawal Rate (4% rule) for retirement planning. And I plan to retire in 25 years; what should be my safe withdrawal rate?
What is a safe withdrawal rate? The safe withdrawal rate (SWR) is the annual withdrawal amount in the first year of retirement divided by the available retirement corpus. Higher the rate, the more difficult it is to take on capital market risk after retirement.
Backtests are usually used to determine an acceptable rate. We use equity and debt market data to determine which rate results in the best results: corpus outliving the individual more often than not. Note: The SWR is only the withdrawal rate in the first year of retirement. Withdrawal rates after that will be naturally higher. As the above articles explain, we need to use a lower SWR than 4%.
It is easy to tell a 25 or even 35-year-old to use 3% or even 2% as a safe withdrawal rate. They have time on their side. However, the available options are limited if a person has just retired or is about to retire with a high withdrawal rate.
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If they use mutual funds (equity/debt) and withdraw an income, the capital will start to erode. There is a huge chance that they will run out of money before their lifetime. If they buy an annuity, they will have little to handle inflation or unexpected expenses. If they buy an assortment of small savings schemes (Senior citizen savings schemes and the like), it will be subject to reinvestment risks – lower interest rates on maturity.
This is why retirement planning is considered the most difficult problem in personal finance or even all of finance. Let us try to appreciate the situation using the freefincal robo advisory tool.
We usually set inflation after retirement as 6%, but this is too high for an initial withdrawal rate of 5%. So setting all other assumptions the same, we try to lower the inflation rate.
The other assumptions include the following:
- Inflation-protected income until the younger spouse reaches 90 (the wife is aged 58)
- Post-tax return from equity: 10%
- Post-tax return from fixed income (invested assets): 6%
- Post-tax return from income-generating assets: 5%
- A four-bucker retirement strategy with
- Income bucket with 100% fixed income for generating inflation-indexed income for the first 15 years in retirement. This minimises sequences of returns risk.
- low-risk bucket with 50 % fixed income (rest equity) expected to grow at a rate of 8 % p.a. Rs. 70,22,138
- medium risk bucket with 30 % fixed income (rest equity) expected to grow at a rate of 9 % p.a. Rs. 36,45,604
- High-risk bucket with 0 % fixed income (rest equity) expected to grow at a rate of 10 % p.a. Rs. 20,60,000
The robo tool would tell us if the corpus is enough to deploy the above bucket strategy or settle for an annuity. There is also a DIY bucket strategy tool for customisation, or we recommend the retirees work with a SEBI-registered fee-only advisor on our list.
So we start decreasing the inflation rate and see when the tool recommends using the bucket strategy: This occurs only if the inflation rate is less than 3%!
Using the DIY bucket strategy tool, we can reduce the stringent requirement on the income bucket. That is, we can reduce the duration of the income bucket from 15Y to 10Y or 7Y and see if a higher inflation rate can be used. Unfortunately, this only increases the acceptable inflation rate by about 1%.
Therfore we conclude that using a retirement bucket strategy with an initial withdrawal rate of 5% is extremely risky unless the retiree significantly downgrades his lifestyle by the lower expense and finds part-time or full-time employment.
The other option is to buy a long term RBI/gilt bond or an annuity for about 75% to 80% of the corpus and invest the rest in a safe small saving scheme. This will guarantee constant income for life (for the couple). Unfortunately, the retiree will also have to lower expenses and find part-time income.
In summary, options are quite limited when the initial withdrawal rate is high. If the retiree has little experience with mutual funds, then a bucket strategy is all the more difficult to implement. A few financial planners consider 4% a high withdrawal state (we share this view).
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