What is Systematic Withdrawal Plan (SWP)?
Mutual funds offer the facility of Systematic Withdrawal Plan (SWP) which enables the investors to periodically redeem their mutual fund investments over a period of time. So, this is exactly the opposite of what Systematic Investments Plan (SIP) offers. SIP allows you to accumulate your savings while SWP allows you to redeem your investments periodically at the prevailing NAV.
The Financial Planning cycle consists of three stages:
Wealth Accumulation, when the investor invests the money over a period of time,
Wealth Creation, when the invested amount grows over the invested period, and
Wealth Distribution, when the investor seeks to enjoy benefits of the funds accumulated in the investment portfolio.
SWP is a withdrawal facility for Stage 3 – Wealth Distribution and hence, suitable for investors who wish to reap the benefits of their accumulated corpus over a period. For example, Mr. Aditya, who has just retired from his job, has accumulated Rs. 2 crores in the course of his working life, and now may want to withdraw Rs. 1 lakh a month to enjoy the next phase of life. He may register an SWP with the mutual fund, which will periodically redeem the investments for value Rs. 1 lakh at a pre-specified date periodically.
How does SWP work?
SWP works in a systematic manner as below:
Investment corpus is accumulated over a period of time by the investor.
The investor registers an SWP with the mutual fund house with desired withdrawal amount and frequency.
The mutual fund house redeems the units as required for the desired withdrawal amount at the prevailing NAV on a periodical basis. The balance units continue to stay invested in the same fund.
Withdrawal amounts are transferred to the bank account of the investor.
Benefits of SWP
SWP empowers the investors with the following benefits:
Meeting the Periodical Cash Flow Requirement of Investors
SWP provides certainty to investors in terms of periodical cash flows, to the extent & available balance in the folio, since the investor himself specifies the periodic withdrawal amount at the time of registration. Such an amount may be fixed by the investor on the basis of periodical cash flow requirements as well as the investment corpus.
Managing the Cash Flow
Making a lump sum withdrawal of the entire mutual fund portfolio, may put the investors into cash surplus position, wherein the funds stay parked in the bank account till utilisation and hence, impacts the returns of the portfolio. Instead, if the redemption would have been made only to the extent of funds so required, the balance money would have continued to earn returns and hence, grown over a period of time. SWP allows you to manage your cash flow on a realistic basis.
Eliminating the Timing Bias
Registering an SWP helps the investors to eliminate the timing bias in terms of redeeming the investments. While the markets are up, you might be inclined to redeem a higher portion of your investments and book profits at higher valuations. This may result in you redeeming higher funds than necessary and also restricting the upside potential in the process for the excess funds so redeemed. SWP helps you avoid any such timing bias and redeems the funds on a periodical basis, irrespective of the market direction. So, you only redeem the investments for the amount of funds so required and your redemption price also gets averaged over a period of time.
For the taxman, it does not matter whether the investor has redeemed his investments through normal process or through SWP. So, the periodical redemptions through SWP are seen as a series of redemptions for the purpose of taxation. As per the Income Tax Act 1961, gains arising from equity mutual funds with a holding period of more than 12 months are taxed at 10% (plus applicable cess and surcharge). However, an exemption of Rs. 1 lakh per year is also available to the investors for such gains, and the investors may accordingly plan their withdrawals in such a manner so as to make the most of this annual exemption.
Considering the certainty in the monthly cash flow through SWP mode, the investors must consider availing this option in order to utilise their investment corpus in a systematic and planned manner.