Here’s Why and How of Systematic Withdrawal Plan (SWP):
With a Systematic Withdrawal Plan (SWP), you can withdraw a chosen sum of money from a mutual fund at specified intervals. The intervals relate to a fixed date of every month/once in every two months or every quarter.
You may initiate an SWP to fulfil your need for regular income or to book profits. It is a strategy to generate additional cash flows in an organised manner without the need to liquidate the entire investment.
The rationale behind a systematic withdrawal plan is to provide you with the money when you need it the most. You may opt for a fixed sum withdrawal or just the capital appreciation on your investments. Ideally, SWP may be initiated from the growth options of mutual fund schemes.
SWP safeguards you against the ups and downs of the market. It also helps to avoid the difficult decision of finding the right time to exit the market.
When should you go for SWP?
The time to initiate SWPs from your fund needs to be envisaged well in advance to get the most out of your investments. It is advised not to go for SWP when you have got surplus cash in hand or when the markets begin its downward journey.
In fact, such times present a great opportunity to initiate or step-up the SIPs. During those times, you should put your money to work to achieve your goal of wealth creation.
Also read: Are SIPs risk free form of investment
Retirement is considered as the favourable time to start an SWP. It is that phase of your life when the regular monthly paycheck ceases. At this time, you require an additional source of income to support your daily needs.
SWP from the mutual fund can come handy as a pension. Along with that, you can enjoy the fruits of systematic investments that you made during your working years.
How long will the SWP last?
It is a complicated question to answer. Ultimately, the length of SWP is determined by two main factors: the size of the corpus and the withdrawal amount. Basically, the higher the frequency and amount withdrawn, the faster will be the rate of reduction of the corpus.
Additionally, till such time the markets are performing well, you would keep milking higher amounts through SWP. On the contrary, if markets are in bad shape, your size of SWP might shrink. Moreover, in the face of continuous bear runs and inadequate replenishment, the fund value may erode beyond repairable limits.
Let’s understand this with the help of a case study.
Imagine that you initiate SWP in a fund by investing Rs 5 lakh. Current NAV is Rs 20, and you own 25000 units. You instruct the fund to do an SWP of Rs 5000 on 1st of every month. Hence, the fund redeems 250 units and Rs 5000 is transferred to your bank account. The remaining fund value after SWP is Rs 495,000 and fund is left with 24750 units.
The markets rise in the ensuing month, and Fund NAV increases to Rs 21 from Rs 20. Now, the fund needs to redeem only 238 units to conduct SWP. It is lesser than units redeemed in the previous month. After doing an SWP, the remaining fund value is Rs 514,750. Hence, the fund value has risen with upward market movement.
Suppose the markets start falling in the next month and fund NAV comes down to Rs 19. Now, the fund has to redeem more units i.e. 263 units to conduct the same amount of SWP. After doing an SWP, the remaining fund value is Rs 460,731. When markets move southwards, an SWP results in depletion of both units and fund value at a greater pace.
Your fund value, thus, fluctuates with every SWP and market ups and downs.
Tax Implications of SWP
When you make withdrawals from the fund via SWP, it attracts tax based on the type of scheme you own. The tax structure for equity funds is entirely different from that of a debt fund.
SWPs follow first in first out (FIFO) method. In this, those units which were bought first are considered for redemption towards SWPs. Thus, your tax incidence on SWP depends on FIFO method and the holding period.
When an SWP is initiated from an equity fund in the 1st year of investment, it is considered as short-term capital gain. Your SWP amount will be taxed at the rate of 15%. However, if SWP is initiated from an equity fund after 1 year of investment, it falls under long-term capital gains. Long-term capital gains are completely tax-free.
So, if possible, try to do an SWP from your equity fund investments upon completion of one year.
Next is; debt mutual funds. In this, the holding period for taxation is 3 years. When an SWP is initiated from a debt fund within 3 years of investment, it is considered as short-term capital gain. Your SWP amount will be taxed as per your income tax slab.
However, if SWP is initiated from a debt fund after 3 years of investment, it falls under long-term capital gains. Long-term capital gains are taxed at the rate of 20%. Additionally, you get the benefit of inflation indexation.
SWPs can immensely help in meeting your income needs. To achieve the maximum benefit, you need to plan your SWP according to your requirements and tax incidence.