As you start your retirement, you will need to replace your salary with another source of regular income. If you have been part of a defined benefit pension scheme or have been investing in a pension plan during your working years, you will not feel as much pinch. Those who have not purchased a pension plan certainly need regular income to replace their salary. Even with the pension, you may not be able to replace your salary entirely through pension and may still need to rely on other means to bridge the shortfall. In this post, I will discuss some of the ways to generate regular income during retirement.
1. Fixed Deposits
You can opt for monthly, quarterly payout option for your fixed deposit.
Pros: Simple. Comfort of years of experience of investing in FDs. Can be opened online or in a bank branch close to your house. Can be liquidated in case of emergency by incurring a small penalty.
Cons: Interest income is taxable. You will not be able to lock-in interest rate. Fixed deposits are typically not available for tenor greater than 10 years. TDS (tax deduction at source) is applicable if interest during the year exceeds Rs 10,000 per annum across the bank.
2. Annuity Plans from Insurance Company
You pay a lump sum to the insurance company and the insurance pays you a fixed amount throughout your life. Essentially, you purchase an income stream from the insurance company.
Pros: Very easy to understand. You need not worry about interest rate going up and down. Insurance company bears the interest rate risk. You have locked in your income stream. The annuity rate increases with age. For very old persons (or those with poor health), who may find it difficult to manage retirement corpus on their own, an annuity plan can be a good option. Comes in multiple variants. Under one variant, you can also guarantee income to your spouse after your death.
Cons: Illiquid. Once you have invested, you cannot take out the money even in case of emergency. Some plans may permit surrender of plan with heavy penalty. Income from annuity plans is taxed at marginal income tax rate in India. Annuity rates are low in India. You can check out the annuity rates for LIC Jeevan Akshay VI. It may not be very difficult to generate this level of income of your own.
3. Senior Citizens Savings Scheme (SCSS)
Interest is paid out every quarter. The interest rate is announced by the Government every quarter. However, a SCSS deposit once opened gets the same interest rate as at the time of opening the deposit. Interest rate changes during the term of your deposit do not affect your interest rate.
Pros: Investment in SCSS is eligible for tax benefit under Section 80C. Interest rate at 8.6% p.a. (as on June 19, 2016) is also on the higher side. You can exit in cases of emergency by incurring a small penalty.
Cons: Interest is taxable. Term is only for 5 years (with an option to extend by another 3 years). Total investment in SCSS is capped at Rs 15 lacs per person (at any point of time). If you count your spouse too, it can go up to Rs 30 lacs (Rs 15 lacs each). You may still need to look for other investment options.
4. Post Office Monthly Income Scheme (POMIS)
Similar to fixed deposits. These deposits are offered by post offices. The interest rate is announced every quarter by the Ministry of Finance. The interest rate (as on June 19, 2016) is 7.8% per annum. Interest is paid out every month. Maturity is 5 years. Anybody can invest in POMIS (unlike SCSS, where only senior citizens can invest). However, since we are discussing income options for retirees, SCSS will be an option for many retirees. SCSS scores over POMIS in almost every aspect.
Pros: No TDS. Premature withdrawal is permitted. You can exit by paying a small penalty.
Cons: Interest is taxable. Your investment in POMIS cannot exceed Rs 4.5 lacs at any point of time. Even with your spouse, total investment will be capped at Rs 9 lacs (Rs 4.5 lacs each) at any point of time.
5. Tax-Free Bonds
Many Public Sector Units have been permitted (permission and quantum of bonds given every year) to issue tax-free bonds by the Government. Last year, many PSU including NHAI, REC, HUDCO and NTPC came out with tax-free bonds. You can also purchase these bonds from secondary market.
Pros: Interest income is not taxed. Suitable for investors falling in the highest income tax bracket. You can lock-in interest rate for up to 20 years. Since the issuers (PSUs) are backed by Government, there is little risk of default. In case of financial emergency, you can exit in the secondary market.
Cons: Bonds issuances are few and far between. The demand is so high that you may not even get the desired allocation. Due to low liquidity (and high spread), you may not be able to exit at a favourable price in the secondary market.
6. Rental Income
Now, you have got to plan for this. You must purchase residential or commercial property much before your retirement if you are banking on rental income for your retirement. No bank will be comfortable offering you a loan during your retirement.
Pros: Easy to understand. You may be comfortable investing in real estate. May fetch you capital appreciation too. Rental income may also provide a hedge against inflation to an extent.
Cons: Rental income is taxable. Rental yields are quite low at 2-3% for residential properties. A fixed deposit will offer better returns. Hence, purchasing a property during retirement just for the sake of rental income may not make much sense. Moreover, you cannot sell your property in parts, if required. Real estate is illiquid too.
7. Systematic Withdrawals Plans in Debt Mutual Funds
Another alternative for regular income is to set up Systematic Withdrawal Plan (SWP) in debt mutual funds. Under an SWP, you invest in a mutual fund and give an instruction to redeem units (worth a specific amount) every month. For instance, you could set up an SWP to redeem units worth Rs 10,000 on 15th of every month.
Pros: Redemption of MF units gives rise to capital gains tax liability. However, sale of debt mutual fund units face favourable taxation if the holding period is more than 3 years. LTCG on debt MFs are taxed at 20% after indexation. This can reduce your tax liability significantly.
Cons: The returns are not guaranteed (unlike in case of fixed deposits). There is interest rate risk. You can suffer capital losses in case the interest rates move up (especially in long duration funds). You can also suffer losses in case of default in underlying security. There are many variants of debt mutual funds available. You need to have the skill the pick up the right MF scheme.
Point to Note: Invest in Growth option of debt mutual funds. It is easy to get confused and invest in dividend option for regular income. Firstly, dividend distribution is not under your control. Moreover, dividends (through dividend distribution tax paid by AMC) are taxed even before the dividend reaches you. DDT for debt mutual funds stands at 28.4%. Hence, dividend option can be highly tax inefficient.
8. Monthly Income Plans (MIPs) from Mutual Funds
The name can mislead you. MIPs provide income in the form of dividends. However, dividend distribution is at the discretion of fund manager. Moreover, a mutual fund scheme can distribute dividends only from surplus (profit) and hence ability to distribute dividend can be compromised in periods of poor performance.
Pros: MIPs have small exposure to equity (15-20%), which can provide growth kicker to your retirement corpus.
Cons: Dividend from debt mutual funds is subject to taxation. Even though you don’t have to pay the tax, the mutual fund house pays it on your behalf. The effective tax rate is 28.4%, irrespective of your income tax slab. Investors in the lowest income tax slab stand to lose out. Moreover, as mentioned above, dividend distribution (timing and quantum) is not under your control and may even be skipped.
9. Other options
There are a few other options that you can consider. You can invest in Corporate fixed deposits or non-convertible debentures. These instruments can offer better returns than a bank fixed deposit but there is an element of risk too. These instruments are not as safe as bank fixed deposits. During retirement, your ability to recover from capital losses goes down drastically. Hence, you must tread with caution.
You can also use your PPF account to generate annual income. However, for that to happen, you must have completed initial maturity of 15 years.
In dire circumstances, you can also opt for a reverse mortgage loan. You wish you never have to think about it.
What This Post Is Not About?
This post is not about retirement strategy. I have merely discussed ways to generate income during retirement. It does not mean you must deploy your retirement corpus into one of these income generating assets. With advancement in medical science, retirement can be really long. Hence, you will do well to park a part of your retirement corpus in growth assets say balanced funds, equity funds etc. Such growth assets are more likely to counter inflation well during your post retirement years. The allocation to these income generating assets and growth assets should be a part of your retirement strategy. Seek professional help, if required.