Systematic Withdrawal Plan is a method where you keep withdrawing some amount of money from your investment at regular intervals (monthly, quarterly, or yearly, depending on what suits you). The money you take out comes from the returns on your investments.
Say you’ve put money into an equity fund. You can then set up a Systematic Withdrawal Plan to take out a fixed amount, like ₹10,000, every month. This ensures that you have a steady source of income without any manual intervention. In other words, you’re simply drawing from the money that’s already been earned and accumulated in your investment. This blog will explore how SWPs work and the effects of inflation on your SWPs.
Why Consider an SWP?
- Steady Income Stream: SWPs are a great way to ensure you have a dependable income stream when regular income from salaries or business profits may no longer be available.
- Flexibility: The decision to choose that amount is entirely yours, for example ₹15,000 or ₹20,000 per month depending on your requirements.
- Better Returns than Fixed Deposits: Ideally, you will earn better returns than a fixed deposit or a savings account as your current corpus keeps growing at the market rate. You can reshuffle your portfolio as per your risk appetite to maximize growth or minimize risk.
How Does an SWP Work?
For example, your current investment corpus is ₹15,00,000 and you wish to withdraw ₹12,000 every month. A practical example:
- Investment Corpus: ₹15,00,000
- Withdrawal: ₹12,000 each month
- Growth: Your fund will continue to grow at the market rate. You’re simply withdrawing from the accumulated returns.
Your investment fund might grow or shrink as per the performance of the market. As a result, the balance in your fund can vary based on market conditions while your withdrawals are fixed.
Note: You’re not selling your entire investment. Instead, you are just withdrawing a small portion of it.
Inflation gradually reduces the value of your money and it poses a significant threat to long-term wealth. This is particularly important for elderly people or those relying on fixed withdrawals, like in an SWP. You will probably need to withdraw more to maintain the same purchasing power and this is where Inflation-Adjusted SWP comes into the play
Inflation Adjusted SWP: Protecting Your Withdrawals Against Inflation
What is an Inflation-Adjusted SWP?
An Inflation-Adjusted SWP is an advanced form of SWP where your regular withdrawals are increased each year to account for inflation. This additional step ensures that the purchasing power of your withdrawals stays constant and you can maintain your standard of living.
For instance, let’s say you’re withdrawing ₹10,000 a month from your SWP in the first year. If annual inflation is 6%, your ₹10,000 won’t buy the same amount of goods or services the next year. So, under an inflation-adjusted SWP, your withdrawal would increase by 6%, making it ₹10,600 per month in the second year.
To calculate how inflation impacts your SWP, you can use FinzGuru – Inflation-Adjusted SWP Calculator. This tool will help you adjust your withdrawals year over year based on inflation.
Why and when to consider an Inflation-Adjusted SWP?
- It maintains purchasing power: An inflation adjusted SWP helps ensure that your monthly withdrawals maintain their value as the cost of living rises. For example, ₹10,000 can be sufficient for you today, but after 20 years, it won’t be sufficient due to less purchasing power. An inflation-adjusted plan will help you to stay ahead of that curve.
- It helps long-term planning: Inflation is a long-term issue and it should be handled like that. It is a necessity to adjust our withdrawals as per inflation. Your money will have less impact over time, and you may find yourself struggling to keep up with rising costs.
- Carries less risk:You can comfortably rely on withdrawals for your daily expenses as you are protecting your buying power. Fixed withdrawals do not offer this advantage and you might end up withdrawing too little
So, how does it work?
Say you have saved ₹20 Lakhs in a mutual fund for your retirement and you are planning to withdraw ₹15,000 each month during the first year (also assume a 6% annual inflation rate).
You pull out ₹15,000 per month during the first year, totalling to ₹1,80,000 for the year.
This withdrawal will increase to ₹15,900 per month in the following year, due to 6% inflation and will further increase to ₹16,854 in the third year due to compounding inflation.
In this scenario, your monthly withdrawal gradually increases to maintain your standard of living, even as inflation rises.
How to Calculate SWP with Inflation Adjustment
Withdrawals in an inflation adjusted SWPs are calculated by simply accounting the inflation rate each year.
For example:
- First Year Withdrawal = ₹12,000
- Inflation Rate = 6% p.a.
- Second Year Withdrawal = ₹12,000 × (1 + 0.06) = ₹12,720
Inflation Adjusted SWP will help you to maintain the same purchasing power by adjusting your withdrawals each year as per the inflation.
Key Considerations
You should consider a few things between SWPs and inflation-adjusted SWPs:
- Market Volatility: SWPs are often linked to investments that can vary with the market. Your investment corpus could shrink in bad times and can grow exponentially during an economic boom. An inflation-adjusted SWP will keep your withdrawals sustainable and maintain the same purchasing power.
- Withdrawal Amount: One of the biggest challenges in an SWP is determining the correct withdrawal amount. Try to keep withdrawals between 4-6% of your initial investment amount per year. Withdrawing too much or too little will lead to unintentional effects such as rapid depletion of the corpus or not meeting your financial needs.
- Taxation: Withdrawals from certain investment vehicles are subject to tax. This tax can impact your effective withdrawal rate. Consult with a financial advisor to plan for this.
Conclusion
A Systematic Withdrawal Plan (SWP) offers a great way to generate regular income. This is useful for retirees without any pay-check coming in.
Inflation affects the value of withdrawals over time by reducing your purchasing power. So, it is important to understand and consider inflation adjusted SWPs. The right approach comes down to your own financial goals. Understanding SWP and inflation adjusted SWP will help you to make smarter choices for your retirement and help you in the long run.
