Determining Regular Income Needs

Financial realities of individuals determine their distinct regular retirement income needs. For instance, a person with dependent parents will have different financial needs compared to a person living with spouse.

Identify expenses seeking to match cashflows

Determine the likely regular expenses in retirement and their periodicity to anticipate regular income needs or cashflows. Excessive investments in lower risk, regular income investments may lead to counter the inflation. Consequently, one needs to draw increasingly from retirement savings with the hope to maintain the standard of living and eventually this may result in depleting your savings.

Establish monthly, quarterly, and annual needs

In your 50s, the items that your purchasing all these years ie your home budget like groceries and mobile communication expenses will broadly remain the same. Of course, there will be changes. For instance, office commute and business attire costs typically get replaced on retirement by items like costs of hobbies like gardening and painting. In late retirement, with declining mobility, health expenses typically take centre-stage.

Regular retirement income plan needs to also account for discretionary expenses for e.g. like dining out besides expenses occurring over longer intervals like every quarter, like quarterly subscriptions, and annually such as annual health insurance premiums.

Determine periodic and lump sum income needs

Periodic needs are like home painting and smartphone upgrades arising every 2-3 years. Lump sums are also needed for needs like social functions like marriage in the family, replacing big ticket expenses ie expensive items like car, boosting emergency fund and regular income.

The plan needs to be able to help maintain lifestyle existing on retirement so that you are in a financial position that shall help you lead a more active retired life compared to previous generations. This contrasts with the traditional approach of budgeting for 80-90% of pre-retirement expenses.

Regular Retirement Income

Let us take a brief look at popular traditional options in India considered during retirement.

Fixed deposits

These are available in banks, post offices and even companies, available for different periods. Interest rates offered for those above 60 years are typically higher than for others but typically lag inflation. The interest income is fully taxable after annual limit of Rs 50,000 of all interest income under Section 80TTB for those above age 60.

National Savings (Monthly Income Account) Scheme

This Small Savings Scheme* popularly known as MIS, is a 5-year monthly income option with an investment limit of Rs 9 lakh for an individual and Rs 15 lakh for a joint account. Interest rates are announced every quarter and thus, a sharp downward revision will impact regular income. Upper investment limit constrains the amount of monthly income possible and premature exit restrictions limit flexibility. Finally, like other deposits, interest is fully taxable.

Senior Citizens Savings Scheme

This is the most popular regular retirement income scheme for people 60 years or older from the Small Savings Scheme stable. The age limit is relaxed to 55 years for those taking Voluntary Retirement Scheme (VRS). It typically provides the highest interest rate in the category, currently 8.2% annually^, with quarterly interest payouts, with an investment limit of Rs 30 lakh per individual i.e., Rs 60 lakh for a married couple. The interest rates are announced every quarter with interest income being fully taxable at the applicable tax rate. There are also penal provisions for premature exits**.

Floating Rate Savings Bonds

This is popularly known with names like RBI Bond Floating Rate Savings Bonds 2020 (Taxable). This 7-year regular income investment option has no age related condition but is popular for government-backed probable regular retirement income. There are bi-annual interest rate announcements and interest payouts***. There is a 35 percentage point (35 basis point) mark up over the prevailing high interest rate for National Savings Certificate (NSC), another popular Small Savings Scheme. The interest income is taxable at the applicable tax rates and the bonds have varying lock-in periods based on investor’s age, limiting planning flexibility.

Annuities

They are regular income investments from life insurance companies for lump sum payment. There are numerous options to choose from like annuities for life or for different periods like 10 and 15 years, with or without the potential return of the principal amount, besides regular income seek to benefit to spouse and children on demise.

Typically, longer the annuity’s period, more the number of people covered and return of principal amount involved, lower the annuity rate and regular income. In the past, they have typically lagged government-backed, high interest paying options like Senior Citizens Savings Scheme. Of course, in National Pension Scheme (NPS), 40% of the savings needs to be mandatorily converted into annuities on reaching vesting age i.e., retirement.

Although annuities help ensure consistent income during a period, they are fully taxable at the income rate and have penal provisions for premature exit. This means you do not have the flexibility in planning and making mid-course corrections.

Fixed income debt mutual funds

Fixed income debt mutual funds, or fixed income funds, are debt mutual funds that invest in debt securities to generate a potential consistent stream of income.

To receive regular income, investors need to also use the Systematic Withdrawal Plan (SWP) facility. Here, a pre-decided amount is paid in fixed intervals such as every month, quarterly, bi-annually or annually by liquidating units as per the SWP form provided to the AMC and as per the provisions mentioned under the Scheme Information Document (SID) for such a facility. Investors can also opt to liquidate units equivalent to the investment’s appreciation.

Depending on the requirement, one can choose from a range of fixed income debt mutual funds. Example, for needs arising in 2-3 years, a person can consider short duration debt mutual funds that invest in debt securities of 1-3 years maturities. They can be supplemented with investments in arbitrage funds.

For needs arising in 3-4 years, higher risk, medium duration debt mutual funds can be considered which invest in debt investments maturing in 3-4 years. For requirements in 4 years, consider dynamic bond funds that invest in debt securities of different maturities to exploit interest rate movements and other opportunities. For a more informed investment decision, one can take the help of an experienced mutual fund advisor. (above statement is for illustration purpose only)

With no withdrawal restrictions, SWP in fixed income funds provide great deal of flexibility with fund managers exploiting interest rate movements and managing reinvestment and credit risks. Of course, capital gains are taxable at the relevant income tax rate.

Seek to Create A Retirement Savings Withdrawal Strategy

I. Determine Investments For Use

Tax outgo on exit is a key factor in determining the pecking order of investments to be used for regular income. High tax payouts early in retirement reduces the benefit from compounded growth for the remaining retirement corpus.

First category for withdrawals
The category consists of tax free retirement benefits like provident fund (EPF), tax free part of gratuity amount, Public Provident Fund (PPF) and tax-free lump sum portion of NPS savings (60% of overall accumulation). The money required for cashflows of 1-2 years can be drawn from these investments with the rest being reinvested to minimise tax outgo. For regular income, consider investing in short term debt mutual funds like short duration debt fund and use Systematic Withdrawal Plan (SWP) facility.

Stagger use of retirement savings
The tax outgo from reinvested proceeds of tax-free retirement benefits can be minimised by deferring or staggering their receipt. This is not an option for gratuity as it must be received on retirement while receiving EPF money can be deferred till age 60.

At the same time, PPF account can be extended for 5 year periods with partial withdrawals made when money is required. Tax-free lump sum from NPS can be withdrawn over 10 annual instalments till the age of 70^#.

Second category for withdrawals
These are investments taxed at lower rates. This means investments like equity mutual funds and hybrid mutual funds such as equity savings funds and balanced advantage funds which are taxed as equities. Capital gains in investments older than 1 year are considered long term capital gains and are tax free up to Rs 1.25 lakh annually. Capital gains exceeding this amount are considered as long term capital gains and need to pay long term capital gains tax of 12.5%.

The withdrawal plan should be such that, approximately 2-3 years before money is required, you gradually move money to appropriate fixed income funds through Systematic Transfer Plan (STP). Subsequently, create regular income with SWP through them and investments in arbitrage funds. This process can be repeated for replenishing cashflows for the subsequent 1-2 years after annual reviews of investments.

II. Decide On Income Bearing Investments

Here, consistency of regular income holds the key and requires reinvestment of part of retirement savings in low risk and liquid option like short duration debt mutual fund. They can be combined with Senior Citizens Savings Scheme and Taxable GOI Bonds for quarterly, half-yearly and annual expenses.

Special situations
Annuities for life, with savings in EPF and NPS, might need to be considered in case of inadequate retirement savings. This provides guaranteed income even as you try to extend work life. This can be topped up with Senior Citizens Savings Scheme and Taxable GOI Bonds.

Subsequently, with more investments, say, due to extended work life, one can plan for short term debt fund-SWP combination. Those with relatively large regular retirement income needs may supplement it with SWP in arbitrage funds. They benefit from lower capital gains tax liability, benefitting from equity fund taxation.

For periodic and lump sum income needs, consider regularly investing in closed-ended debt investments such as target date maturity debt mutual funds and fixed maturity plan (FMP). This “laddering’ strategy will create an “income ladder’ with regular maturities of investments and can be supplemented by medium duration debt mutual funds.

For a need about 3-4 years away one can similarly adopt a “Bullet” strategy where closed-ended debt fund investment are progressively made so that they mature on a particular date. The portfolio for such a need can also have medium duration debt funds and dynamic bond funds.

To sum up, replacing your paycheque in retirement is not only about efforts in work life but also careful planning the use of your retirement savings. With that combination of efforts, you will never miss in retirement the notification for your salary credit.

Source Reference

* https://www.nsiindia.gov.in/(S(hy0yba55lsbfyl45d15w1wj3))/InternalPage.aspx?Id_Pk=188

** https://www.indiapost.gov.in/VAS/DOP_PDFFiles/Savings%20Bank/Senior%20Citizen%27s%20Savings%20Scheme%202019%20English.pdf

*** https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11923&Mode=0

# https://npscra.nsdl.co.in/nps-exit/

^ https://www.nsiindia.gov.in/(S(3brku3asvxn3t5e5qdfkzrae))/InternalPage.aspx?Id_Pk=132