Systematic Withdrawal Plan

We all have different financial goals. So, we choose different investment strategies and financial instruments to achieve our goals. There are several tools that are designed to help investors with their financial journey. One such tool is the Systematic Investment Plan (SIP), which is perfect for newbie investors. As SIPs help investors invest strategically, Systematic Withdrawal Plans (SWPs) help them withdraw their investments in a planned manner.

In this article, we will discuss what Systematic Withdrawal Plans are, how they work, their benefits, and how you can do an SWP in mutual funds.

A Systematic Withdrawal Plan (SWP) is a facility that allows an investor to withdraw money from an existing mutual fund at predetermined intervals. It helps investors to create a regular flow of income from their investments. You can withdraw your money monthly, quarterly half yearly, or annually on dates chosen by you. It ensures a regular cash flow for your income needs.

SWP is the exact opposite of the Systematic Investment Plan (SIP). In SIP, a fixed amount is transferred on a regular basis from your bank account to the mutual fund. However, in SWP, the flow of transactions is reversed. The tool of SWP is helpful for investors who require regular cash flows for meeting their expenses.

Suppose you have 10,000 units in a mutual fund scheme. Using SWP, you have asked the fund house to withdraw ₹5,000 every month. On 1st January, the NAV of the scheme is ₹10. So, the equivalent number of MF units = ₹5,000/₹10 = 500. Hence, 500 units will be redeemed and ₹5,000 would be given to you. Now, you have 9,500 remaining units (10,000-500 = 9,500).

Next, on 1st February, the NAV is ₹15. Thus, the equivalent number of units = ₹5,000/₹15 = 333. Hence, 333 units would be redeemed from your mutual fund holdings, and ₹5,000 would be given to you. Now, you have 9,167 remaining units (9500-333 = 9,167). This process will continue until the time you want the withdrawals.

When you choose the SWP, you can withdraw as much as you want from the fund since there is no upper limit on the amount you can withdraw. However, you have to keep in mind the total corpus you have in the scheme and how long it can last. For example, suppose you have ₹50 lakh in a scheme, which offers a 7% average annual return. In this case, you can choose a monthly SWP of ₹50,000, it will last for slightly over 12 years. But if you lower the SWP amount to ₹40,000, it will last you for more than 18 years.

There are two types of Systematic Withdrawal Plans available for investors. They are Fixed Withdrawal and Variable Withdrawal.

Using this method, you can withdraw a fixed sum at regular intervals. On the fixed date, units equivalent to the SWP amount will be redeemed and the money will be transferred to your bank account. For example, let's say you have invested some amount and have purchased 20,000 units in a mutual fund. You choose SWP and ask your fund house to withdraw ₹10,000 on the 1st of every month. The first withdrawal date is fixed on January 1, 2023.

Now, let's assume that the NAV of the fund is ₹10. Hence, in order to withdraw ₹10,000 every month, the fund house will have to redeem 1000 units every month (10000 /10 = 1000). Hence, after the first month's withdrawal, you have 19,000 units remaining (20,000 - 1000 = 19,000).

Let's say that the mutual fund performs well and its NAV changes to ₹15 on February 1, 2023. So, when you withdraw ₹10,000 in February, you will have to redeem 666.67 units (10,000/15 = 666.67). Post this withdrawal, you will have 18,333 units (19,000 - 667 = 18,333). This process will continue and using this calculation, you can calculate the remaining units or investment amount.

In this SWP, only the appreciation on the fund or gains is withdrawn. Let's say, you have invested ₹1 lakh in a mutual fund scheme, whose NAV increased by 2% in the first month. This means you have earned a gain of ₹2,000. Hence, the capital gain of ₹2,000 will be withdrawn from your investment.

Calculating the withdrawal value and the remaining invested amount can be difficult to calculate manually. Hence, you can use an SWP plan calculator and get all the necessary information with ease. You can check out the Koshex SWP calculator to see how it works.

You can use Systematic Withdrawal Plans for the below reasons.

For Secondary Income - SWPs can be a great source of creating an additional income stream for investors from their long-term investments. It can help them tide over the increasing living cost. Hence, investing for the long term in mutual funds and withdrawing regularly via SWP may be an easy way to create a regular source of secondary income.

For Capital Protection - Conservative investors can invest in moderate or low risk mutual fund schemes and receive only the capital gains as SWP.

For Your Own Pension - SWPs are suitable for retirees, who do not have any pension earnings. With SWPs, they can create their own pension by investing the retirement corpus in schemes that suit their risk profile and earn a regular income at a frequency of their choice.

For People In High Tax Bracket - SWPs are a pretty useful tool for investors in high tax brackets as there is no TDS (tax deducted at source) on the capital gains. Also, the capital gains from equity/equity-oriented mutual funds are taxed moderately. Gains from debt-oriented mutual funds are also moderate as indexation is allowed on long-term capital gains.

Let us take a look at how you can plan for an SWP.

Understand Your Financial Needs - Calculate how much you need to withdraw monthly or quarterly to meet your financial needs. Decide how long you want the withdrawals to last. This could be based on life expectancy or a specific financial goal.

For Capital Protection - Conservative investors can invest in moderate or low risk mutual fund schemes and receive only the capital gains as SWP.

Pick The Right Fund - Consider choosing relatively stable funds, like debt funds, balanced funds, or conservative hybrid funds. You need to make sure that the chosen fund matches your risk appetite.

Set Up The SWP - The first thing you need to decide on is the withdrawal amount and frequency (monthly, quarterly, semi-annually, or annually). The next step is to choose a starting date for your SWP. Also, understand the tax implications of your withdrawals.

Monitor & Adjust - Review your SWP periodically to make sure it meets your income and is sustainable.

Check The Impact On Investment - Understand that withdrawals might erode your principal investment over time, especially if the withdrawal rate is higher than the fund’s growth rate.

There are a few major risks associated with SWPs and they are:

Market risk - If your SWP is based on investments in equity mutual funds, the value of your investment can fluctuate significantly because of market volatility.

Longevity risk - There is a risk that you may outlive your savings, especially if the withdrawal rate is too high compared to the returns generated by your investment. This is an important consideration for retirees.

Inflation risk - If your investment returns don’t outpace inflation, your withdrawals may not be sufficient to meet your future needs.

Interest rate risk - If your SWP is based on debt mutual funds, rising interest rates can lead to a decline in the value of your fund’s holdings. This can potentially affect your withdrawals.

Taxation risk - Frequent withdrawals might lead to short-term capital gains, which are taxed at a higher rate.

Here are some ways in which you can mitigate these risks:

There are several benefits to choosing systematic withdrawal plans. Here is a list of advantages.

In an SWP, the investor has the flexibility to choose the amount, frequency, and date according to their needs. On top of that, the investor can stop the SWP at any point in time or they can add further investments or even withdraw amounts over and above the fixed SWP withdrawals.

When you choose the SWP, some mutual fund units will be automatically redeemed every month which will help you meet monthly expenses, irrespective of market levels. This method stops investors from withdrawing large amounts because of panic or fear during volatile market situations. SWP allows withdrawals even when markets are witnessing new highs, thus protecting investors from impulsive investment during boom periods.

SWP in mutual funds helps investors by offering a regular source of income from their investments. You can choose how much ever amount you wish to redeem for how much ever time you need that income. This can be extremely helpful for those investors, who have attained retirement, or for those, who need an extra cash flow to meet expenses like their child's educational expenses.

If the SWP withdrawal rate is lower than the fund return, you can get capital appreciation in the long term.

If planned properly, SWPs can be a great instrument to help you meet your financial goals. With SWPs, you can earn a second income, apart from your regular salary. It can help meet your goals from being delayed because of the unavailability of cash or a cash crunch. If you set the redemption time at the time when you need money the most, SWP can add great value to your financial life.

Since tax is usually payable only on the income component and not on the capital component, SWPs are a great option 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 ₹1 lakh.

For equity mutual funds, tax has to be paid on the gains from equity at 15% on the withdrawn sum if the holding period is less than one year. For debt mutual funds, if the money is withdrawn within three years, the returns are treated as a part of income and taxed on the basis of the relevant slab rates. On the other hand, for debt mutual funds, if the money is withdrawn after three years of investments, the gains are taxed at a rate of 20% after indexation. Hence, this is more profitable.

For resident individual investors, there is no TDS (tax deducted at source) on the SWP amount.

As mentioned above, the regular redemption of units using the SWP feature is subject to taxation. If you have investments in equity mutual funds and the holding period is less than one year, your short-term gains will attract a Short-Term Capital Gains (STCG) tax of 15%. If the holding period is more than 12 months, the gains over and above ₹1 lakhs thus realized will be subject to 10% Long-Term Capital Gains (LTCG) tax without indexation.

With debt mutual funds, if your holding period is less than 3 years, the capital gains made through SWP will be added to your income and taxed as per your income tax slab rate. If the holding period is more than 3 years, the capital gains would be long-term and attract a tax of 20% with indexation.

Systematic Withdrawal Plans (SWP) are an ideal investment option for investors who are looking to create a second income, no matter how old they are, as young investors can use the amount for day-to-day expenses and old investors can use the withdrawals for their post-retirement expenses. SWPs can be viewed as a better investment option than Fixed Deposits as there is no TDS with SWPs.

We hope this article helped you learn more about Systematic Withdrawal Plans, their benefits, who is it suitable for and how can you use it to get the best out of your investments.

If you want to see how much corpus you need to build to receive a certain amount every month, you can use our SWP Calculator. All it takes are a few clicks and there you go, making big calculations with ease.

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