Browse Analysis of Managed and Structured Products

18.4.3 Withdrawal Plans

Guide on various withdrawal plans for investors in mutual funds, including ratio withdrawal plans, fixed-dollar withdrawal plans, fixed-period withdrawal plans, and life expectancy-adjusted withdrawal plans.

18.4.3 Withdrawal Plans

Withdrawal Plans

A mutual fund’s shareholders have a continual right to withdraw their investment in the fund simply by making the request to the fund itself. In return, they receive the dollar amount of their net asset value. This characteristic is known as the right of redemption and it is the hallmark of mutual funds.

Withdrawal plans have evolved to meet the needs of investors who require regular income and tax efficiency, and who do not want to withdraw their entire investment in a lump sum. Retired and retiring investors most commonly fit this profile. To meet their needs, many funds offer one or more systematic withdrawal plans. In simple terms, rather than withdrawing the entire amount at once, the investor instructs the fund to pay out part of the capital invested, plus distributions, over time. Withdrawals may be arranged monthly or quarterly, or at other predetermined intervals.

If the fund invests its assets successfully, the increased worth of its shares helps offset the reduction of principal that results from withdrawals. However, if the investment decreases in value, the investor’s entire investment may be extinguished earlier than expected. This is a real risk that must be explained to investors contemplating withdrawal plans.

Ratio Withdrawal Plan

A ratio withdrawal plan lets investors receive an annual income from the fund by redeeming a specified percentage of fund holdings each year, usually between 4% and 10%, depending on the amount of income required. Obviously, the higher the percentage, the more rapid the depletion of the initial investment. Since payouts are based on a percentage of the fund’s value, the withdrawal amounts may vary each year.

Here is an example assuming a portfolio growth of 8% per year and annual withdrawals of 10% of the fund’s value at the beginning of each year.

    %% Example: Ratio Withdrawal Plan
	
	gantt
	    dateFormat  YYYY
	    section Year 1
	% of fund value : a1, 2019-01-01, 2019-12-31
	Withdrawn:   done, a2, 2019-01-01, 2019-01-01
	Growth(%):   active, a3, 2019-01-01, 2020-01-01
	
	    section Year 2
	% of fund value : a4, 2020-01-01, 2020-12-31
	Withdrawn:   done, a5, 2020-01-01, 2020-01-01
	Growth(%):   active, a6, 2020-01-01, 2021-01-01
	
	    section Year 3
	% of fund value : a7, 2021-01-01, 2021-12-31
	Withdrawn:   done, a8, 2021-01-01, 2021-01-01
	Growth(%):   active, a9, 2021-01-01, 2022-01-01
1Table: Ratio Withdrawal Plan
2
3| Year  | Value at Beginning of Year  | Percentage Withdrawn  | Value of Withdrawal  | Value at End of Year  |
4|-------|------------------------------|-----------------------|----------------------|-----------------------|
5| Year 1 | $100,000                     | 10%                    | $10,000              | $97,200              |
6| Year 2 | $97,200                     | 10%                    | $9,720               | $94,478              |
7| Year 3 | $94,478                     | 10%                    | $9,448               | $91,833              |
8| Year 4 | $91,833                     | 10%                    | $9,183              | $89,262              |
9| Year 5 | $89,262                     | 10%                    | $8,926              | $86,763              |

Fixed-Dollar Withdrawal Plan

A fixed-dollar withdrawal plan allows the investor to withdraw a specified dollar amount monthly, quarterly, or annually. Unlike the ratio plan, the dollar amount remains constant which means that if withdrawals exceed the fund’s growth, the principal is eventually depleted.

Here is an example assuming annual withdrawals of $10,000.

    %% Example: Fixed-Dollar Withdrawal Plan
	
	gantt
	    dateFormat  YYYY
	    section Year 1
	$ Withdrawal: a1, 2021-01-01, 2021-12-31
	Star : milestone, m0, 2021,2021-01-01
	Growth:       active, a2, 2021-01-01, 2021-12-31
	
	    section Year 2
	$ Withdrawal: a3, 2022-01-01, 2022-12-31
	Star : milestone, m1, 2022-01-01
	Growth: active, a4, 2022-01-01, 2022-12-31
1Table: Fixed-Dollar Withdrawal Plan
2
3| Year  | Value at Beginning of Year  | Fixed Withdrawal  | Value at End of Year  |
4|-------|------------------------------|-------------------|-----------------------|
5| Year 1 | $100,000                     | $10,000           | $97,200              |
6| Year 2 | $97,200                     | $10,000           | $94,176              |
7| Year 3 | $94,176                     | $10,000           | $90,910              |
8| Year 4 | $90,910                     | $10,000           | $87,383              |
9| Year 5 | $87,383                     | $10,000           | $83,574              |

Fixed-Period Withdrawal Plan

A fixed-period withdrawal plan allows for a specified amount to be withdrawn over a predetermined period with the total capital being exhausted by the end of the plan.

Here is an example assuming the plan is collapsed over five years, and withdrawals are made at the beginning of each year.

    %% Example: Fixed-Period Withdrawal Plan
	
	gantt
	    dateFormat  YYYY
	    section Year 1
	Withdrawal Period: active, a1, 2019-01-01,2019-12-31
	
	    section Year 2
	Withdrawal Period: active, a2, 2020-01-01,2020-12-31
	
	    section Year 3
	Withdrawal Period: active, a3, 2021-01-01,2021-12-31
	
	    section Year 4
	Withdrawal Period: active, a4, 2022-01-01,2022-12-31
	Withdrawal Period: active, a5, 2023-01-01,2023-12-31
1Table: Fixed-Period Withdrawal Plan
2
3| Year  | Percentage of Capital Withdrawn  | Value at Beginning of Year  | Value of Withdrawal  | Value at End of Year  |
4|-------|-----------------------------------|-----------------------------|----------------------|-----------------------|
5| Year 1 | 20%                               | $100,000                     | $20,000              | $86,400              |
6| Year 2 | 25%                               | $86,400                      | $21,600              | $69,984             |
7| Year 3 | 33.33%                            | $69,984                      | $23,328              | $50,388             |
8| Year 4 | 50%                               | $50,388                      | $25,194              | $27,209             |
9| Year 5 | 100%                              | $27,209                      | $27,209              | $0                  |

Life Expectancy-Adjusted Withdrawal Plan

A life expectancy-adjusted withdrawal plan is a variation of the fixed-period withdrawal plan, where withdrawals are aligned with the plan holder’s expected life span, based on actuarial tables. The withdrawal amount adjusts continuously according to the fund value and the plan holder’s revised life expectancy.

Here is an example assuming the client is age 75 and expected to live until age 85.

    %% Example: Life Expectancy-Adjusted Withdrawal Plan
	
	gantt
	    dateFormat  YYYY
	    section Year 1
	Grant:   active, g1, 2021-01-01,2021-12-31
	Life Expectancy Assessment
	
	    section Year 2
	Grant:   active, g2, 2022-01-01,2022-12-31
	Life Expectancy Assessment
 1Table: Life Expectancy-Adjusted Withdrawal Plan
 2
 3| Year  | Value at Beginning of Year  | Life Expectancy – Current Age  | Value of Withdrawal  | Value at End of Year  |
 4|-------|------------------------------|--------------------------------|----------------------|-----------------------|
 5| Year 1 | $100,000                    | 10                              | $10,000              | $97,200              |
 6| Year 2 | $97,200                     | 9                               | $10,800              | $93,312              |
 7| Year 3 | $93,312                     | 8                               | $11,664              | $88,180              |
 8| Year 4 | $88,180                    | 7                               | $12,597              | $81,896              |
 9| Year 5 | $81,896                     | 6                               | $13,649              | $74,447              |
10 === ........)

Frequently Asked Questions (FAQs)

What are the advantages of a withdrawal plan?

Advantages include regular income, tax efficiency, disciplined investment strategy, and better management of fund principal according to personal needs.

What happens if the value of my investment decreases?

If the fund’s value decreases, planned withdrawals will result in more rapid depletion of principal, meaning funds could be exhausted earlier than anticipated.

Key Takeaways

  • Right of Redemption: You can withdraw your mutual fund investment anytime at the current value.
  • Systematic Withdrawal Plans: These include ratio, fixed-dollar, fixed-period, and life expectancy-adjusted plans.
  • Investor Risk Awareness: Ensure investors are aware that adverse fund performance can exhaust invested principal prematurely.
  • Life Expectancy Adjustment: Aligns withdrawals according to life expectancy, providing better longevity-based financial planning.

By understanding the different withdrawal plans available, an investor can select a strategy that aligns with their income needs and financial goals.


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markdown ## What is the hallmark characteristic of mutual funds that allows shareholders to withdraw their investment at any time? - [ ] Fixed growth rate - [ ] Guaranteed returns - [x] Right of redemption - [ ] High liquidity > **Explanation:** The hallmark of mutual funds is the right of redemption, which allows shareholders to withdraw their investments by making a request to the fund itself. They receive the net asset value of their shares. ## What is the primary purpose of systematic withdrawal plans in mutual funds? - [ ] To invest in new funds regularly - [ ] To reinvest dividends and interest - [x] To provide regular income without withdrawing the entire investment in a lump sum - [ ] To avoid paying taxes > **Explanation:** Systematic withdrawal plans are designed to provide investors with regular income and tax efficiency without requiring them to withdraw their entire investment in a lump sum. This is especially beneficial for retirees and those needing periodic payouts. ## In a ratio withdrawal plan, what determines the amount withdrawn each year? - [ ] A fixed dollar amount - [ ] A percentage based on life expectancy - [x] A specified percentage of fund holdings - [ ] Current interest rates > **Explanation:** In a ratio withdrawal plan, an investor receives an annual income by redeeming a specified percentage of fund holdings each year. The percentage chosen for redemption typically ranges between 4% and 10%. ## Which of the following is true for fixed-dollar withdrawal plans? - [ ] The withdrawal amount varies based on fund performance - [x] The withdrawal amount is a fixed dollar value - [ ] Withdrawals can only occur annually - [ ] The value withdrawn is proportional to market performance > **Explanation:** In fixed-dollar withdrawal plans, the fund holder specifies a fixed dollar amount to be withdrawn at predetermined intervals (e.g., monthly or quarterly). This amount remains constant, irrespective of the fund's market performance. ## What risk should investors be aware of with withdrawal plans? - [ ] Receiving dividends instead of interest - [ ] Incurring high transaction fees - [x] The possibility that the investment may be extinguished earlier than expected due to fund value decrease - [ ] Deferring tax obligations > **Explanation:** Investors should be aware that if the fund's investment decreases in value, their entire investment may be depleted earlier than expected. This risk must be communicated to investors considering withdrawal plans. ## In a fixed-period withdrawal plan, what determines the withdrawal amounts? - [ ] A percentage of the current fund value - [ ] A fixed dollar amount - [ ] Reinvested dividends and earnings - [x] A specific fraction of the capital is withdrawn at each interval > **Explanation:** In a fixed-period withdrawal plan, a specific fraction of the capital is withdrawn at the beginning of pre-determined periods with the intention that all capital will be exhausted by the end of the plan. ## How does a life expectancy-adjusted withdrawal plan differ from a fixed-period withdrawal plan? - [ ] Withdrawals remain constant throughout the plan - [ ] Withdrawals depend on market performance - [x] Withdrawals are continually readjusted based on the plan holder’s changing life expectancy - [ ] Withdrawals are a fixed dollar amount > **Explanation:** A life expectancy-adjusted withdrawal plan is a variation where the withdrawals are based on periods that are continually readjusted according to the plan holder’s changing life expectancy, making use of mortality tables. ## Which type of withdrawal plan involves the depletion of investment at the end of a specific period? - [x] Fixed-period withdrawal plan - [ ] Fixed-dollar withdrawal plan - [ ] Ratio withdrawal plan - [ ] Dividend reinvestment plan > **Explanation:** A fixed-period withdrawal plan aims to deplete the entire investment by the end of a predetermined period, withdrawing a specific fraction of the capital at the beginning of each interval. ## In the example provided for the ratio withdrawal plan, what percentage did the investor choose to withdraw annually? - [ ] 8% - [ ] 5% - [ ] 12% - [x] 10% > **Explanation:** In the ratio withdrawal plan example provided, the investor chose to withdraw 10% of the fund holdings at the beginning of each year. ## Which factor is crucial for explaining the potential earlier depletion of investments to investors considering withdrawal plans? - [ ] The fixed withdrawal amount - [ ] The investor’s life expectancy - [ ] The fund's management fees - [x] The possibility of the fund's investment decreasing in value - [ ] The amount of dividends received > **Explanation:** It is important to explain the risk that if the fund's investment decreases in value, the investor's entire investment may be extinguished earlier than expected. This crucial factor should be communicated to investors contemplating withdrawal plans.

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