The tool of SWP is helpful for investors who want regular cash flows for meeting their expenses.
Systematic Withdrawal Plan, popularly known as SWP, is an investment feature available with mutual funds through which investors can withdraw from their existing investments in the form of fixed amounts at regular intervals. Withdrawals can happen monthly, quarterly, half yearly or annually on dates chosen by the investors. It ensures a regular cash flow for your income needs.
SWP is the opposite of Systematic Investment Plan (SIP). In the latter, a fixed amount is transferred on a regular basis from your bank account to the mutual fund while in the former the flow of transaction reverses. The tool of SWP is helpful for investors who want regular cash flows for meeting their expenses.
How does SWP work?
An SWP allows you to withdraw a fixed amount regularly from your investments in a mutual fund scheme. When an investor opts for an SWP, he systematically receives his own money from the ongoing investment by redeeming some mutual fund units.
Simply put, a part of your mutual fund units holding will be sold to honour the amount of payout you have specified on a regular basis. Payments through SWP would continue as long as you have units left in your holding if a duration for the SWP is not provided.
For instance, if you have invested a lump sum of Rs 1 lakh in a fund with an NAV of Rs 10, you will have 10,000 units of that scheme.
If the amount that you wish to withdraw, let’s say, every month is Rs 1000; the fund will sell units worth Rs 1000. Suppose, if you start the SWP after a year and the NAV is at Rs 20 when the withdrawal day comes.
So, the fund will sell 50 units of yours and get you the required sum of Rs. 1000. This would result in a reduction in the number of your units to 9,950.
In case the NAV reaches Rs 25 at the next payout day, the fund will sell 40 units to honour the Rs 1000 payout and your number of units will further reduce to 9,910.
Let’s understand this in actual terms. Suppose you have started an SWP for Rs 1000 on a lump sum investment of Rs 1 lakh for 5 years in an equity mutual fund scheme.
The expected rate of return, say, is 10%. In the span of 5 years (60 months), you will get a total payout of Rs 60,000 while the value of the rest of your investment post completion of 5 years will be Rs 84,490. So, essentially, investors keep getting their regular monthly cash flow by redeeming units while the rest of the units keep appreciating along with the market valuation.
How to make the best use of SWP
SWP ensures regular cash flow. If an investor has a sizeable lump sum amount to invest for instant regular withdrawal, opt for SWP as soon as the investment is made. However, it is advisable that investors should start an SWP in their equity scheme at least one year after the investment to save on the short term capital gains tax of 15%.
If one is better financially planned, SWP features should be added after a couple of years, say 5-7 years, as this time duration helps capital appreciation. It helps to have a larger quantum of regular cash flows.
Moreover, investments made through the SIP mode can also be added with the SWP feature whenever you want. If you have been investing through an SIP till your retirement and do not want to invest more, you should consider stopping the SIP but not complete redemption. Rather, the best way to reap the benefit of the sizeable corpus is by way of SWP. This way, a regular monthly flow will be more like a pension for you and can sustain your needs for quite a longer duration of time because the rest of the corpus will remain invested and continue to appreciate.
It is worth adding that despite the SWP, you are free to redeem more whenever the need arises.
Taxation on withdrawals through SWP
The regular redemption of units using the SWP feature is subject to taxation. If you have investments in equity funds and the holding period is less than a year, your short-term gains resulting due to redemption via SWP will attract an STCG tax of 15%. However, if the holding period of investment is more than 12 months, the gains over and above Rs 100,000 thus realised will be subject to 10% LTCG tax without indexation. So if you realised your units with an LTCG of Rs 125,000, you need not pay taxes on the first Rs 100,000, but the rest Rs 25,000 will be taxed at 10%, resulting in a tax of Rs 2500 plus applicable cess.
On the other hand, on debt funds, if your holding is less than 3 years, the capital gains thus made through SWP will be added to your income and taxed as per your income tax slab rate. If your holding is more than 3 years, capital gains would be long-term and attract a tax of 20% with indexation.
However, such regular withdrawals are not subject to tax deduction at source (TDS) as is the case with fixed deposits.
SWP is an effective tool to generate cash flow. However, it should be financially planned keeping your goals in mind. Unplanned way of opting for an SWP may prove detrimental to your finances.
(The author is CEO, Bankbazaar.com)
As an expert in personal finance and investment strategies, I can confidently affirm the significance of the Systematic Withdrawal Plan (SWP) as a valuable tool for investors seeking regular cash flows to meet their expenses. My in-depth knowledge of financial instruments, particularly mutual funds, allows me to provide comprehensive insights into the workings of SWP and its implications for investors.
Understanding SWP: SWP is a feature offered by mutual funds that enables investors to withdraw fixed amounts at regular intervals from their existing investments. This can occur monthly, quarterly, half-yearly, or annually, depending on the investor's preference. The primary goal of SWP is to ensure a steady cash flow to meet the investor's income needs.
Distinguishing SWP from SIP: In contrast to the Systematic Investment Plan (SIP), where a fixed amount is regularly invested, SWP reverses the transaction flow. Instead of investing, investors systematically receive money from their ongoing mutual fund investments by redeeming units.
Mechanics of SWP: When an investor opts for SWP, a fixed amount is withdrawn regularly from their mutual fund scheme. This involves redeeming a portion of mutual fund units, and the payouts continue until the investor's unit holding is depleted or a specified duration for SWP is provided.
For example, if an investor has 10,000 units in a fund with an NAV of Rs 10 and wants to withdraw Rs 1,000 monthly, the fund will sell units worth Rs 1,000. The number of units sold depends on the NAV at the withdrawal time.
Optimizing SWP: To maximize the benefits of SWP, investors are advised to start it at least one year after the initial investment in equity schemes to minimize short-term capital gains tax. Alternatively, incorporating SWP features after 5-7 years enhances capital appreciation, resulting in a larger quantum of regular cash flows.
Moreover, SWP can be added to SIP investments, providing a consistent monthly flow resembling a pension, while the remaining corpus continues to appreciate.
Taxation Considerations: SWP redemptions are subject to taxation. In equity funds, short-term gains (holding period < 1 year) attract a 15% Short-Term Capital Gains (STCG) tax. For holding periods exceeding 12 months, gains over Rs 100,000 incur a 10% Long-Term Capital Gains (LTCG) tax without indexation.
Debt funds follow a different taxation pattern, with gains within 3 years added to income and taxed at the applicable slab rate. Long-term gains in debt funds (holding period > 3 years) incur a 20% tax with indexation.
It's crucial for investors to plan SWP in alignment with their financial goals to avoid adverse consequences on their finances. Proper planning ensures that SWP serves as an effective tool for generating cash flow without compromising long-term financial objectives.
