How to derive income in retirement

Let's assume you've made all the right moves and are now sitting on a princely sum to see you through your silver years. Your priority now is setting up a distribution plan that gives you a regular income after retirement.

Now, an income-generating portfolio, as you well know, will need to have a very different asset allocation from a growth-oriented portfolio. Therefore, as you transition from the accumulation phase of retirement planning to the distribution phase, you need to make a shift in your asset allocation away from equities towards debt options.

It is best to start on this project four-five years ahead of retirement. After taking all this trouble to accumulate a sizeable retirement corpus, you don't want a sudden bear market to batter your portfolio right when you turn 60. Imagine a 2008-like situation, where the market was down over 50 per cent in a single year! The best way to avoid such last-minute shockers is to initiate a phased shift in your asset allocation from an equity-heavy portfolio to a more balanced one, starting five years ahead of your retirement date.

While rejigging your portfolio, where do you invest the money? Let's illustrate with the case of Sathya, who has a Rs 3 crore corpus. Her corpus is 25 times her annual expenses of Rs 12 lakh. She needs to invest it in three buckets.

Emergency fund
Financial planners advise having six months' living expenses in an emergency fund during your working years. It is best to continue with this during your retirement years as well, especially because there's no external income to cushion you from life's adversities. This fund is meant to meet unforeseen emergencies. In any case, you should buy a separate seniors' health-insurance plan, on the cusp of retirement, to see you through medical emergencies.

For Sathya, setting up an emergency fund will mean parking Rs 6 lakh in a bank deposit which offers a premature withdrawal facility. Sathya should not be touching this money except in case of emergencies and must refill it after every withdrawal.

Income generation
Having set aside an emergency fund, it is desirable to create a wholly debt-oriented portfolio to tide over the first five years of your retirement. Relying wholly on debt for your income needs in the first five years will ensure that your hybrid or equity allocations have a sufficient runway to grow before you begin withdrawing from this portion of your portfolio.

For your income-generation needs in the first five years, you have two options to choose from. If you're a savvy investor who is quite comfortable with mutual funds, you can invest the entire proceeds in three-four short-duration debt funds and set up a systematic withdrawal plan (SWP) equal to your living expenses every month. While choosing such funds, be sure to go for the ones that don't take on credit risks and invest in most conservative instruments. It doesn't matter if their returns are below the chart-toppers in the category. In Sathya's case, this would mean investing Rs 60 lakh (five years' expenses) in three-four carefully chosen short-duration funds with low credit risks and setting up SWPs from them.

If you're not a very savvy investor and like absolute safety, you can maximise your investments in government-guaranteed schemes to earn you an assured income and allocate the rest to debt funds. This will mean parking Rs 15 lakh in the Senior Citizens Savings Scheme (SCSS) at your post office or a leading bank. The scheme, with a five-year lock-in, revises its interest rates every quarter but is offering 8.6 per annum currently. The interest is taxable, while your initial investment of up to Rs 1.5 lakh a year is tax-exempt under Section 80C.

A second safe option is the Pradhan Mantri Vaya Vandana Yojana offered by LIC, where for an upfront payment of up to Rs 15 lakh, you can earn a regular pension at the guaranteed rate of 8 per cent for the next 10 years. The pension received is taxable and your money is locked in for 10 years. You'll receive Rs 10,000 per month on an investment of Rs 15 lakh.

In Sathya's case, she could invest Rs 30 lakh in the above schemes and the Rs 30 lakh left over in short-duration debt funds. Do note that SWPs from debt funds are more tax-efficient than other guaranteed return options because of the indexation benefit on capital gains after three years.

Growth portfolio
Having created an emergency fund and an income portfolio for her initial post-retirement life, Sathya would have drawn down a total of Rs 66 lakh from her accumulated retirement corpus of Rs 3 crore.

Now, to ensure that her remaining retirement portfolio doesn't simply stagnate, the Rs 2.34 crore that she is left with should be invested in a balanced manner with a sizeable equity allocation. While many people balk at the idea of having any exposure to equities in their retirement years, equities are a must to beat inflation in your post-retirement life, which may stretch on for 30 years or more.

The only way your retirement portfolio will last you for a lifetime is if the returns on it total to your annual withdrawal rate plus the inflation rate. Assuming your annual withdrawal rate from your retirement kitty to meet your living expenses is 4 per cent and inflation averages 6 per cent a year, your post-retirement corpus will still have to generate a 10 per cent return to last you a lifetime. This kind of return is clearly not possible with a fully fixed-income portfolio.

In Sathya's case, we would recommend investing half of the Rs 2.34 crore, i.e., Rs 1.17 crore across three multi-cap equity funds. If she already had good multi-cap equity funds in her portfolio before retirement, she can plan her redemptions in such a way that Rs 1.17 crore remains invested equally in them. The remaining Rs 1.17 crore can go into short-duration debt funds. Set up an SWP directly from the short-duration funds in her portfolio and replenish the outgo from the multi-cap funds.

The above investment plan will leave Sathya with about 40 per cent of her post-retirement money invested in equities and she should be prepared for considerable volatility in this component over short periods. In the years where stock markets plummet, it would be important to stay off redemptions or withdrawals from the equity component of her portfolio, while relying entirely on the debt component.

Can you get away with a lower equity allocation than Sathya's? That would depend entirely on your annual withdrawal rate and the inflation rates you experience. To ensure that your retirement portfolio lasts you a lifetime, you should be withdrawing no more than 4-5 per cent of it in the first year and grow the amount at your projected inflation rate each year after that.

So, if you find that you can live with just a 3 per cent withdrawal rate from your portfolio, or if inflation turns out to be just 5 per cent in your retirement years, you'll need to target an 8 per cent post-tax return. That may be quite possible with an equity allocation of 20-30 per cent.