How to use the Systematic Withdrawal Plan in Mutual Funds? 

A Systematic Withdrawal Plan (SWP) is an investor-friendly measure that allows the investors in mutual funds to withdraw funds periodically. As such, one may enjoy the benefits of wealth accumulated in the past through periodical redemptions. Thus, SWP aims to achieve precisely the opposite of what Systematic Investment Plans (SIP) offer. While SIP allows the investors to channelise their savings from their bank account into mutual funds, SWP allows the investors to transfer their wealth from mutual funds into their bank accounts. 

How does an SWP work?

The working of a Systematic Withdrawal Plan (SWP) is explained below:

1. The investor channelises the savings in mutual funds in the past, which may have also grown over time.

2. When the investor needs regular cash flows, they may register an SWP with the mutual fund house with specified periodicity as well as withdrawal amount. 

3. Mutual fund units are redeemed periodically as per the prevailing valuations. 

4. While the redemption proceeds are credited to the bank account of the investor, the remaining portfolio continues to stay invested in the same mutual fund scheme. 

Systematic Withdrawal Plan Benefits 

1. Fixed Cash Flows to the Investors

Investors enjoy flexibility in terms of specifying a fixed amount that they may choose to withdraw from their investments periodically. Such amount may be fixed based on their monthly cash requirements, including monthly expenses, as well as the investment corpus. This gives an edge to the investors over dividend plans, since the certainty of cash flows is not guaranteed under dividend plans. 

2. Systematic Withdrawal of the Investments

If the investor chooses to make a lumpsum withdrawal of his/ her mutual fund investments, the overall investment returns may be impacted. This is because the surplus funds may be required to be parked in bank accounts pending utilisation, which generally provides lower returns. On the other hand, SWP allows the investors to plan the withdrawals systematically, and the balance investment portfolio continues to stay invested.

3. Mitigating the Timing Risk

When one registers an SWP, the investors may mitigate the timing risk involved in redeeming their investments at lower valuations. This is because the SWP redemptions continue to be made across the market direction, wherein units with low value will be withdrawn when the markets are high, and a greater number of units are redeemed when the markets are lower. When the investor needs to push such redemptions manually, the greed and fear psychosis may impact the redemption strategy. 

Who should do a Systematic Withdrawal Plan (SWP)?

SWP allows the investors to receive a fixed amount in their bank accounts, and the proportionate units are deducted from the investment portfolio. As such, SWP is advisable for the retired people who are looking to utilise the investment corpus for their monthly cash flow requirements. Further, as per the Union Budget 2020, as passed by the Parliament, no TDS is deductible on the mutual fund redemption transactions, as against the dividend options, which renders additional benefit to the investors in terms of higher cash flows. 

Taxation of Systematic Withdrawal Plans

Investors must note that SWP is not an investment product in itself but only an option to automate the process to redeem the investments periodically. As such, it is immaterial under the Income-tax rules if the redemption is processed through SWP, or the investor has made redemption transactions manually. 

As per the prevailing tax laws, gains arising from equity funds with an investment period of 12 months or more are considered as Long-Term Capital Gains (LTCG) and taxed at 10% without any indexation benefit. However, Rs. 1 lakh exemption is also available in respect of aggregate LTCG from equity shares and equity funds in a year. Accordingly, the investors may also plan their SWP amount in such a manner that such an exemption limit is availed in full. As such, SWP may further enhance the tax efficiency of mutual fund investments. STCG in equity funds with a holding period of less than 12 months is taxed at 15%. 

Further, if the investor has invested in a debt fund, the gains from debt funds with a holding period of 36 months or more are classified as LTCG and taxed at 20% post the indexation benefit. STCG in debt funds with an investment period of less than 36 months is taxed at the regular tax rates applicable to the investor. 

Since an SWP renders certainty to the investors in respect of cash flows, they may consider registering SWP to utilise their investment portfolio systematically.

Note: The tax rates, as mentioned in the article are for illustrative purposes only and are updated as per the Union Budget 2020 passed by the Parliament. The tax rates for capital gains will be as per the tax laws applicable on the date of redemption/ sale and not on the date of investment.