When you retire, you will no longer have a regular salary. Therefore, your savings must generate a steady income stream to support your expenses. The National Pension System (NPS) and a Systematic Withdrawal Plan (SWP) from mutual funds are two popular choices for individuals planning for retirement.
In this story, the comparison assumes the current NPS exit structure, where a portion of the corpus is used to buy an annuity and the balance remains invested.
Investors are often faced with a choice regarding their retirement- should they opt for NPS or invest in equity mutual funds and do an SWP once they retire? To make this decision, retirees should evaluate factors such as liquidity, flexibility, taxation, and the ability of income to keep pace with inflation.
Though they function differently, you should be aware that both investment alternatives produce consistent income during your retirement. To determine which investment instrument can produce a more sustainable retirement income flow, you must compare NPS and mutual fund SWPs before making any decisions.
Suppose two retirees each accumulate a corpus of Rs 1 crore at age 60. How would their monthly cash flows compare over the next 25 years?
Please note that 100% lump-sum withdrawal is permitted only for a NPS corpus (up to Rs 8 lakh). Since the corpus in this illustration is Rs 1 crore, the maximum lump-sum withdrawal assumed is 80%, with the remaining 20% used to purchase an annuity.
Assumptions:
According to Subhendu Harichandan, Executive Director, Anand Rathi Wealth, here are the assumptions made for the calculation of the example mentioned below.
Retiree A: Uses the revised NPS exit option by withdrawing Rs 80 lakh as a lump sum and investing it in an 80:20 equity-debt portfolio. The remaining Rs 20 lakh is used to purchase an annuity, providing a guaranteed income stream. The invested corpus is used to supplement the annuity income.
Retiree B: Accumulates Rs 1 crore through equity mutual funds and keeps the entire corpus invested in an 80:20 equity-debt portfolio. Retirement income is generated through an SWP.
How would their monthly cash flows and remaining wealth compare over the next 25 years?
| Retiree A: NPS (20% Annuity + 80% Lumpsum)* | Retiree B: Equity MF SWP** | |
| Corpus at 60 | Rs 1 crore | Rs 1 crore |
| Annuity Purchase | Rs 20 lakh | Nil |
| Invested Corpus | Rs 80 lakh | Rs 1 crore |
| Monthly Income at 60 | Rs 41,667 | Rs 41,667 |
| Monthly Income at 75 | Rs 99,857 | Rs 99,857 |
| Monthly Income at 85 | Rs 1.78 lakh | Rs 1.78 lakh |
| Total Income Received | Rs 2.95 crore | Rs 2.95 crore |
| Corpus at 85 | Rs 1.74 crore | Rs 2.70 crore |
Source: Anand Rathi Wealth
**SWP is at 5% and stepped up 6% every year to match inflation.
*NPS annuity rate of 6.5% on Rs 20 lakh. The remaining Rs 80 lakh is invested in an 80:20 equity-debt portfolio earning 10% annually and is used to supplement annuity income.
Eg:
Rs 10,833 (annuity) + Rs 30,834 (invested corpus) = Rs 41,667
Rs 10,833 (annuity) + Rs 89,024 (invested corpus) = Rs 99,857
Rs 10,833 (annuity) + Rs 1,67,167 (invested corpus) = Rs 1.78 lakh
Key notes to consider from the above table:
We have not added back the Rs 20 lakh annuity purchase amount at the end. The table compares the retirement income received during the 25-year period and the remaining invested corpus at age 85.
The Rs 20 lakh used to purchase the annuity is already generating the annuity income of Rs 10,833 per month, which has been included in the cash flow calculations. Its benefit is already reflected in the income figures.
If the annuity chosen includes a Return of Purchase Price feature, the original Rs 20 lakh may be paid to nominees upon death. However, the above table focuses only on retirement cash flows and the remaining corpus, and does not separately account for any amount that may be received under the Return of Purchase Price feature.
Both retirees start with the same Rs 1 crore corpus at age 60 but follow different retirement income strategies. Retiree A combines an annuity with an invested corpus under NPS, while Retiree B keeps the entire corpus invested and withdraws through an SWP.
Subhendu Harichandan says that while both can generate similar retirement income, the key difference is that the SWP investor keeps a larger portion of the corpus invested throughout retirement, resulting in a higher remaining corpus by age 85.
Inflation erodes purchasing power over time. Which option handles inflation risk better?
Inflation steadily erodes purchasing power over time. With inflation averaging around 6% annually, prices roughly double every 12 years. As a result, the fixed annuity income received by Retiree A buys significantly less by age 85, even though the payout remains unchanged.
Retiree B keeps the entire corpus invested and can gradually increase withdrawals over time. With continued exposure to equities, the portfolio has a better chance of keeping pace with inflation, helping preserve purchasing power throughout retirement.
How should retirees structure SWP withdrawals so that income rises with inflation without exhausting the corpus prematurely?
Investors would have to do the maths to understand this. If your withdrawal rate is at least 4-5% lower than your return rate, the corpus lasts indefinitely and can even grow.
“If we consider the retiree to have an 80:20 allocation in equity to debt, then on Rs 1 crore earning 10% annually, the portfolio generates Rs 11 lakh a year. If you withdraw only Rs 5 lakh (5%), the remaining Rs 6 lakh stays invested and compounds. Start at 5% of corpus (Rs 41,667/month) and increase withdrawals by 6% every year to match inflation. As long as annual withdrawals stay at or below 6-8% of the corpus, the portfolio not only survives 25 years but continues growing throughout,” said Subhendu Harichandan.
For example, Mr A retires with Rs 1 crore and buys an annuity. Mr B retires with Rs 1 crore and starts a 5% SWP. Who receives more income by age 85, and who leaves behind more wealth?
Both retirees can generate broadly similar retirement income by age 85. However, Mr B leaves behind more wealth because the entire Rs 1 crore remains invested and continues to participate in market growth.
In contrast, Mr A allocates a portion of the corpus to an annuity, which provides guaranteed income but reduces the amount available for long-term growth. As a result, the SWP approach leaves behind a larger corpus and offers greater flexibility in retirement.
What factors should retirees evaluate before choosing between NPS and an SWP strategy?
Retirees often face a choice between using NPS or building a retirement corpus through mutual funds and generating income via an SWP. Key factors to consider include liquidity, flexibility, taxation, and protection against inflation.
Recent NPS rule changes have increased withdrawal flexibility and reduced the compulsory annuity requirement for many subscribers. However, depending on the corpus size and applicable rules, a portion of the retirement corpus may still need to be used to purchase an annuity. While annuities provide a guaranteed income stream, payouts are typically fixed and may not keep pace with inflation. Annuity income is also fully taxable at the retiree’s slab rate.
In contrast, an SWP allows retirees to decide how much to withdraw while keeping the corpus invested. Only the capital gains portion of each withdrawal is taxed, making it potentially more tax-efficient. As a result, an SWP offers greater flexibility, better inflation protection, and more control over retirement income and wealth.
Disclaimer: This article is for informational and educational purposes only and should not be construed as investment, retirement, tax, or financial planning advice. The illustrations, return assumptions, annuity rates, inflation rates, and withdrawal strategies used in the examples are hypothetical and meant solely to explain the concepts of NPS and mutual fund SWPs. Actual outcomes may vary depending on market performance, annuity rates, taxation, inflation, investment costs, withdrawal patterns, regulatory changes, and individual financial circumstances. Investors should carefully assess their risk appetite, retirement goals, liquidity needs, and tax implications, and consult a qualified financial advisor before making any investment or retirement planning decisions. Past performance and illustrative projections do not guarantee future results.
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