A systematic withdrawal plan (SWP) is the process of withdrawing from the fund on a regular basis by redeeming units at a specific date. It can be done on a monthly, quarterly, annual basis.
No. of units redeemed is calculated based on the withdrawal amount and the NAV of the scheme on that specific date.
This is ideal for someone who requires periodic cash flow over a long period of time with the benefit of capital appreciation if the chosen fund is Growth Oriented.
Why is the need for the SWP option to be exercised?
Till March 2020, the Dividend payout option which is renamed as IDCW (income distribution cum capital withdrawal) serves the purpose of regular cash flow to investors. But during budget 2020, changes were bought in, effect from April 2020, dividend distribution tax is passed on to investors where TDS provisions are applicable and the dividend received in the hands of the investors will suffer tax as per their income slab. Hence, SWP makes an ideal option to meet the needs of investors who require regular cash flow with tax efficiency.
SWP should be done in an equity fund post 1 year so as to ensure that the withdrawal does not attract short term capital gain tax, equity-oriented mutual fund has a 15% capital gain tax rate for the short term. In debt-oriented funds also, to get the benefit of indexation, it is advisable to choose SWP after the holding period of 3 years.
Why choose the SWP option instead of other regular cash flow options.
Flexibility:
When choosing SWP, there is enough flexibility to choose. You can determine whether to go for a fixed amount and how long you want the cash flow to come and also if you do not require cash flow, you can terminate it and restart it whenever required.
Capital appreciation:
Usually, retirees look for regular cash flow and they choose Post-office MIS (monthly income scheme) or Senior citizens savings scheme (SCSS) for regular cash flow. What they miss out on is that at the end of the tenure, invested capital remains where it is without factoring in inflation. While withdrawing regular cash flow at a fixed percentage (6% from the capital) in the SWP option, if someone can stay invested for 7 years and above, capital will also grow which also aids in wealth creation in spite of the withdrawal. The longer they stay invested, the better the corpus will be and it will also help them to leave behind an estate!!
Taxation:
There is no TDS (tax deduction at source) for the SWP option as Mutual funds work in the principle of FIFO (first in, first out). Your cost for the purpose of taxation will be considered as per the FIFO method only. Hence, it is a tax-efficient tool during withdrawal as there is 1 lakh exemption in equity funds and CAPITAL GAINS beyond Rs.1 lakh is taxed at 10% in equity-oriented funds and debt funds enjoy the benefit of indexation with a holding period of 3 years. This is much better than conventional fixed income instruments.
Liquidity:
SWP is only a tool and Incase if they wish to withdraw the capital, which can be done anytime during the period and it is fully democratic investment. Kindly note that SWP is a need-based redemption done on a regular basis instead of lumpsum withdrawal so as to serve the purpose of regular cash flow which can be monthly, quarterly, half-yearly (or) annually depending on the requirement.
Example of how SWP works:
Assuming that you have invested Rs.10 lakh in a fund during its launch, NAV is 10. then you have 100000 units, then, you wish to withdraw Rs.5000 per month through SWP. While withdrawing 5000 per month, then from this scheme, 500 units are being sold, (500/10), leftover units are (100000-500 = 95000 units).
If there is an increase in NAV say after 1 year, assuming the NAV is 20, then with the same withdrawal of Rs.5000 mean selling (5000/20=250) units only where the units redeemed are less compared to last year due to the GROWTH in NAV. During withdrawal, you will always see a lesser no. of units but the capital appreciation will take care of the growth in the portfolio. (Due to this, only a 6% cap in withdrawal is always an ideal number which is very similar to the regular cash flow in conservative debt investments).
I have enclosed a past performance data sheet just for your illustration only, see the growth in the portfolio if someone can have the regular cash flow for 26 years and the growth in the investment after 6% withdrawal being done for 26 years.
Initial investment: Rs.10 lakhs.
Monthly withdrawal: 5000
Withdrawal is done for 26 years (5000*12*26) =Rs.15,60,000
Market value as on today: 8.8 crore.
