Mutual Funds Strategy 120: How to calculate the annual retirement withdrawal percentage
The 4% withdrawal rule was coined by Bill Bengen in the mid 90s and made popular by “Trinity Study” in the late 90s. The essence is very simple — withdraw at a rate that will ensure your retirement portfolio will last for the next 30 years. source.
The implementation is also very simple. If you have Rs 1,00,00,000 in your retirement account, then withdraw 4% of 1 Crore = Rs 4,00,000 per year or Rs 33,333 per month.
Is it practical? Absolutely yes, if you are in the US, and absolutely no, if you are in India. The reason — Inflation. The original model calculates inflation at 2%, whereas in India, the actual inflation is nearly 6%. There is no point withdrawing 4 lakhs per year if you are losing 6 lakhs per year to inflation.
The 4% calculator was set in the US in the 90s by assessing portfolios that had 60% equity exposure and 40% debt exposure, right from the 1900s. I guess the annual returns of their portfolio were between 5% to 6%, accounting for inflation at 2%. Their stock markets, in particular, and the stock markets of other countries, in general went on a different trajectory after the 2000s once the interest rates of bonds were slashed. A 60:40 portfolio in stocks:bonds was no longer attractive, and people wanted more exposure to stocks for higher returns. This has severely impacted the retirement corpus calculations and the ideal withdrawal rate.
Basically, this problem has not hit the ground yet for Indian retirees. People who started investing in the 2000s will retire only between 2025–30. Once they start initiating the systematic withdrawal plans, they will realize the real trouble they are in.
The best solution is to get our inflation to the 2% global standard, but that is something beyond our control. The thing that is in our control is to define our retirement corpus and set a withdrawal plan to ensure it lasts for the next 30 years.
How to set the SWP calculator
Our stock markets have given an annual return of 13%, if you deduct 6% (inflation), it means the real returns are only 7%. Do not be shocked, the real returns for fixed deposit adjusted returns are only 1%, equity mutual fund is still better 7x times.
When you open any SWP calculator, there will be an option to enter the expected rate of returns — specify 7% there instead of 13% and this is how the final results look — 1.77 lakhs at the end of 30 years.
The complication is that the stock market may have given an average return of 13%, but if it gives consecutive years of negative returns, our corpus would exhaust much more rapidly and would not last 30 years.
At 66000 per month, you are looking at an annual withdrawal of 7.92 lakhs ~ 7.92% of corpus per year. The effects of inflation will be felt in the first year, wherein you are withdrawing close to 8 lakhs, of which 6 lakhs is going away due to inflation. From the 2nd and 3rd year, our calculator has already offset the effect of inflation and there is nothing to worry about.
Even if the market returns are 13%, we are considering only 7% as real returns, as we are keeping a safety level loss of 6% due to inflation. The end result is that our capital will compound faster and inflation will drag it down, but our net capital withdrawal will still be possible at a decent rate.
The above was the best case, and usually, the stock markets do not go up at constant returns to scale. Markets may go up or down in any particular year, and it could even stay flat for multiple years
If the markets are not going up 13% or more, there is no way you can withdraw at 8% per year and expect the funds to last the entire 30 years. Either you have to hire a qualified advisor who will help you with this, or manually monitor your fund’s annual returns every year.
Even if the government CPI (consumer price inflation) reports suggest that inflation is 5.35% in a year, it is safer to round it off to 6%. Your withdrawal slab is highly dependent on this 6% calculation.
- If your funds return 13% or more in a year, you can go ahead and withdraw upto 8% that year.
- If your fund’s return is between 12% to 6%, your withdrawal should be between 7% to 1%.
- And, if your funds return anything lower than 6%, you need to be really worried, as any withdrawal will lead to fund exhaustion.
Do not worry, I am not trying to scare you, but these are some precautionary steps that should be taken to preserve your capital because during the retirement phase, you may not have an active income, and the expenses have to be met from these withdrawals.
The upkeep required at your end would be to check the Systematic Withdrawal Calculator (SWP) once a year to reassess your retirement portfolio and set the withdrawal percentage accordingly. This is required only in the initial years, as our inflation-adjusted calculator will take care of things down the line.
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