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Chapter 4 Systematic Withdrawal Plan (SWP) and how to smartly use SWP?

Systematic Withdrawal Plan is exact opposite of SIP; in SIP an investor invests a particular amount periodically for a pre-specified time period whereas in SWP an investor receives a specific amount for a particular period. Thus, SWP is a facility offered by mutual funds to systematically redeem units. SWP allows investors to withdraw from their investments at regular intervals to meet their goals. The regular intervals can be monthly, quarterly or annually.

There are two withdrawal options available in SWP – Fixed Periodic withdrawal and Appreciation withdrawal.

Fixed Periodic withdrawal

In a fixed periodic withdrawal, an investor chooses a fixed amount to receive after interval specific timeframe. Mutual fund house will sell units and transfer the amount in the investor’s account.

Appreciation Withdrawal

In appreciation withdrawal, an investor chooses to withdraw only the return generated on his corpus. For example, if an investor has a corpus of Rs 1 cr in a mutual fund and the fund has given a return of 1% in last one month then he will only get Rs 1 lakh for that month. Therefore, an investor can create a perpetuity using appreciation withdrawal; however the cash flow will not be same as returns are not fixed.

Benefits of SWP in Mutual Funds

Regular Income

The primary benefit of SWP is that an investor will receive regular cash flow.

Tax advantages

The capital gains from equity mutual funds after 1 year of investment are tax free and capital gains from debt mutual funds after 3 years of holding period are taxed at 20% post indexation. Therefore, if a person chooses SWP on its equity mutual funds investment after one year, he does not have to pay tax on capital gains. And if he starts SWP on debt mutual funds after 3 years of investment period, he will pay only 20% tax on inflation adjusted returns.

How to smartly use SWP?

Best Substitute for Pension

SWP, if smartly used, can be the best substitute for Pension. Pension received from the pension plans like NPS is taxable in India. Even the regular income that investor will receive from annuity plans is taxable as per the income tax act. Whereas, we have already mentioned above that mutual funds have better tax advantages on capital gains. So during the accumulation stage of retirement planning, investors should invest in equity and balanced mutual funds and as they start approaching their retirement they should start investing their retirement corpus in arbitrage fund and debt mutual funds. Arbitrage funds are equity mutual funds, thus there will be no tax on capital gains and they are low risk investments. Debt mutual funds are also low risk investments but long term capital gains are taxable; however the tax payable on long term capital gains from debt mutual funds is less as the returns are adjusted for inflation. So, if a debt mutual fund has give 8% p.a. return in last 3 years and the inflation during the that period was 6% per annum then the investor will pay 20% tax on 2% return.

Best way to meet recurring goals

Investors can also use SWP to meet the recurring goals like child’s education in similar way as described above on how investors can make SWP a substitute for their pensions. Similarly, investors should initially invest for their financial goals and as they reach their goal they can choose SWP to receive periodic payments.

Key Takeaways

  • SWP allows investors to withdraw from their investments at regular intervals to meet their goals.

  • There are two withdrawal options available in SWP – Fixed Periodic withdrawal and Appreciation withdrawal.

  • The primary benefit of SWP is that an investor will receive regular cash flow.

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