A systematic withdrawal plan abbreviated as SWP is primarily a smart plan that allows you to withdraw fixed amounts of money at periodic and regular intervals from your mutual funds. Just like a SIP, i.e. a Systematic Investment Plan allows you to invest systematically at regular intervals for a large corpus, an SWP allows withdrawal in parts.
The most convenient aspect of an SWP is that the investors can decide the amount to withdraw as per their requirement while continuing to invest in the chosen scheme. SWP can be especially beneficial to those looking to create an extra income source apart from the regular income. Through SWP’s usually allow regular cash flow, the specific scheme’s dividends and profits may not be guaranteed every month.
An investor can choose from the periodic payout interval options such as monthly, quarterly, half-yearly or annually, as per individual financial needs. With every withdrawal, the value of the investment made is reduced by those many units and also its market value.
Here are some important details on systematic withdrawal plans for investors who are considering this option.
Understanding systematic withdrawal plans better
Here is an example to better understand the concept of a systematic withdrawal plan. Let’s assume that Mr. Arun purchased 200 units of a mutual fund scheme for Rs. 50,000 in February 2021. As part of SWP, he requested that Rs. 10,000 be paid out on the 1st of every month. Thus, units worth Rs. 10,000 would be redeemed every month.
With each withdrawal, there will be a decline in the total number of units available. If the NAV is higher, you might need to redeem fewer units. On the other hand, if the NAV falls, it would require the redemption of more units. The primary parameter of using SWP is individual financial needs and goals. Unplanned withdrawal can be a huge blow to one’s investments and wealth creation plan in the long run.
SWP’s allow investors to withdraw systematically; aiding financial planning. An investor can choose between withdrawing a set amount from the investment or only the appreciated sum using the appreciation withdrawal option on a monthly or quarterly basis as per individual choice.
How does SWP Work?
Here is how SWP works:
- An investor needs to choose a mutual fund and the amount they want to invest in it.
- They need to specify the frequency and amount of withdrawal as per their requirement.
- The mutual fund will sell units of the scheme to meet the withdrawal request and credit the amount to the investor’s bank account.
- The number of units redeemed depends on the NAV (Net Asset Value) of the scheme on the day of withdrawal.
- Depending on the mutual fund and the plan chosen, an SWP may attract exit loads, taxes, and other charges.
Advantages of systematic withdrawal plan
There are several advantages offered by SWPs, some of them are as follows:
- Investment discipline
With SWP, an investor can automatically redeem some mutual fund units every month to meet monthly expenses, irrespective of market levels. Thus, it protects against withdrawing large amounts from panic/fear during volatile market situations. It allows withdrawals even when markets are experiencing new highs and therefore, protects investors from impulsive investment during boom periods.
- A steady source of income
SWP’s can help your finances by ensuring a steady and regular flow of income as per your chosen period. It can be of great help, especially if you have attained retirement or when you need an extra cash flow to meet expenses like your child’s educational expenses.
- Meeting financial goals
If planned on time, SWPs can be a great asset for you and help you meet your financial goals easily. A second income, besides the salary, is always an added benefit. It can help meet your goals from being delayed due to the unavailability of cash or cash crunch. If set for redemption at a time when you need the most, SWP is a great value addition.
- Tax Benefit
Since tax is usually payable only on the income component and not the capital component, SWP can be a great way to benefit from tax efficiency. Withdrawals on the SWP are treated as a combination of Capital and Income.SWPs also enjoy tax exemption for up to Rs. 1 lakh on long-term capital gains. The investor needs to pay tax only on earnings in excess of Rs. 1 lakh. In the case of equity funds, tax is to be paid on the gains from equity at 15% on the withdrawn sum if the holding period is less than a year.In the case of debt funds, if it is withdrawn within 3 years, the returns are treated as a part of income and taxed on the basis of the relevant slab rates. On the other hand, if it is withdrawn after 3 years of investment, then the gains from equity mutual funds are taxable at a rate of 20% after indexation, which is, of course, more profitable.
Here is an example to better understand the tax benefits. Let’s assume that Mr. Arun has invested Rs. 10 lakhs in a mutual fund and with a 10% growth, its value is now Rs. 11 lakhs. If he decides to withdraw an amount of Rs. 1 lakh at the end of the year, only 10% of his withdrawal, i.e. Rs. 10,000 is considered income and the remaining Rs. 90,000 is considered as a capital withdrawal. On the other hand, if he would have received Rs. 1 lakh as interest on a principal of Rs. 10 lakhs, the entire Rs. 1 lakh would have been taxable as it would be treated as income.
Who can use SWP?
Systematic Withdrawal Plans can act as a crucial instrument for those who are planning their retirement. Usually, the retirement benefits are invested in traditional investment sources, which often attract heavy tax rates. Instead, if a lump sum investment is made in mutual funds with an SWP facility, it can earn capital appreciation on the invested amount. It can also offer a fixed amount every month. This can help retirees get a regular income even after retirement.
Apart from retirees, SWP can be beneficial for anyone who requires an additional source of funds, be it to support their family or plan for expenses.
Tools like Systematic Investment Plans and Systematic Withdrawal Plans are carefully planned to benefit investors. These can help you plan and meet your financial goals without having to go through the hassle of keeping track of the market and making wrong money-related decisions that can lead to huge financial losses.
Frequently Asked Questions
Investing in Mutual Funds and choosing the SWP option is a great way of creating a regular source of secondary income. It also allows flexibility in selecting the withdrawal amount as per individual financial needs.
Yes, SWP can be very useful for retirees who are looking for a regular source of income apart from any other stream of income coming through savings.
FD interest is entirely taxed (unless it is a tax-saving long-term FD). In the case of SWP, the taxation is on capital gains and is classified as short-term or long-term capital gains tax. Also, if the SWP is on an equity fund, it can generate higher returns depending on factors such as portfolio composition, market fluctuations, etc.
Yes, the amount redeemed through SWP will take the same time as a normal mutual fund redemption.