Read to understand the meaning of a systematic withdrawal plan or SWP in mutual funds and how it works
I want to understand how exactly the SWP option works. I mean, if I put up a lumpsum amount today and from next month onwards I want the income, can I do that? Secondly, if I can start withdrawing money from the second month itself, then will it not affect my base capital? - Krutika Kathal Khadekar
Investing is not just about entering the market in a staggered manner. Having an exit plan is also important so you can redeem investments methodologically. Just like how a systematic investment plan (SIP) protects you from market volatility by investing periodically, a systematic withdrawal plan (SWP) allows you to redeem in a phased manner and protects you from redeeming all your investments at a market low. It averages the price at which you exit the market.
Compared to a 'dividend' plan of a mutual fund, an SWP is more suitable for retirees, who are typically looking for a fixed flow of income. Though dividends act as a decent income source, they are not efficient since dividends are not guaranteed and the amount and frequency are at the discretion of the fund house. One also may or may not receive dividends every month.
On the other hand, an SWP allows the investors to have the freedom to choose the amount they wish to withdraw as well as the frequency at which they want to do so. You instruct the fund house to redeem a fixed amount on a particular day every month and credit the proceeds to your bank account. Once instructed, it works on autopilot.
SWPs work exactly the opposite of SIPs. Like in an SIP, a particular amount is deducted from your bank and invested every month. In SWPs, you already have an investment with the fund house and instruct them to redeem a part of it and credit it to your bank account every month. This is a more reliable way if you need this money for your living expenses.
For example, if you have Rs 1 crore invested in a mutual fund and you need Rs 50,000 every month for your living expenses. You can instruct the fund house to redeem units worth Rs 50,000 on the 5th of every month. This instruction will automatically redeem the units and the money will be transferred to your bank account.
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However, one should keep two things in mind:
This is a general principle and ensures that one continues to get inflation-adjusted income and doesn't end up outliving their savings. So if your portfolio is earning 8 to 9 per cent every year and your withdrawal is around 5 per cent, the balance will help in the growth of the capital and provide inflation-adjusted income during the later years of your retirement. To ensure that you don't outlive your savings, it is important to leave a part of your returns to help grow the capital and not consume all the returns every year.
When it comes to tax implications, any redemption, be it SWP or in lump sum, is subject to taxation. However, one must note that only the realised gains are taxed and not the complete redemption amount.
If you're withdrawing from a non-equity-oriented fund and your holding period is three years or less, the capital gains will be added to your overall income and taxed according to your income tax slab rate. But, if your holding period is longer than three years, then the capital gains are taxed at 20 per cent after indexation.
In the case of equity-oriented funds, if your holding period is one year or less, the gains are termed as short-term capital gains and are taxed at the rate of 15 per cent. But if the holding period is more than one year, the gains will be long-term capital gains and taxed at 10 per cent.
Suggested read: Deriving income from investments