KNOWLEDGE CENTRE Mutual Fund Types / What is a Systematic Withdrawal Plan?

What is a Systematic Withdrawal Plan?

All that has a beginning, has an end. In the same way, the investments that you make are for a financial goal and thus they as well have an expiry date. Some would be for huge expenses such as children’s higher education or marriage, while others would be for regular income after retirement. Thus, when these events occur, the investment is withdrawn and spent on the event for which it was being accumulated.

A Systematic Withdrawal Plan is like a reverse Systematic Investment Plan (SIP), wherein you can regularly withdraw amounts from your mutual fund investments as a source of secondary income. These withdrawals do not attract the dividend distributions tax as applicable to dividends received from debt fund investments. Systematic Withdrawal Plans are primarily used for making pension plans due to this reason.

How Does A Systematic Withdrawal Plan Work?

Let us go through a practical example to understand the workings of mutual fund investments in SWP. Mrs. Shah has an invested corpus of INR 20 lakh and wishes to receive INR 20,000 every month for the next 4 years that she intends to stay on a sabbatical. She could invest the entire amount in an SWP, get the desired income and have a substantial amount of balance after 4 years.

Assuming that the SWP is an equity or growth fund and earns 15% against the withdrawal of 12%, Mrs. Shah would not be depleting her principal at all. She could continue to be on a sabbatical for perpetuity, even if the earnings dropped to 12%.

However, if she chooses to invest in a debt fund, that would earn her 9%, it would last her for more than 15 years. Even if this was a case of retirement, 15 years is long enough a period considering the average life expectancy of females in India was 69 years in 2015.

What Are The Benefits Of Investing In Systematic Withdrawal Plan?

Now that you know what systematic withdrawal plans are, the next question that arises is whether they are the right choice for you. To help you decide, here are four benefits that these plans offer:

1. Better Returns Than Fixed Deposits
2. Tax Benefits Offered On Withdrawals
3. Protect Your Money From Inflation
4. Provide You With A Regular Source Of Income

1. Better returns than fixed deposits

Since the funds in an SWP are invested in mutual fund schemes, these earn better returns when compared to a fixed deposit (FD). Therefore, it enables you to achieve financial stability for a longer period from the same corpus of the fund that you have invested.

2. Tax Benefits Offered on Withdrawals

When invested in debt mutual funds, you certainly earn better than you would from an FD. However, you would also attract a dividend distribution tax on the earnings. The only tax applicable to the earnings you make from an SWP are under the other income head of your personal income tax calculations.

SWP mutual fund investments are taxable on the first in first out (FIFO) principle. This means the units purchased first are assumed to be redeemed first. If you invest in an equity fund and redeem the units after 12 months, your income is liable to long-term capital gains (LTCG) tax which is 10%. In case you redeem the units before 12 months, the earnings are liable for short-term capital gains (STCG) tax, which is 15% presently.

If your investments are in debt funds, LTCG tax is applicable if you redeem the units three years from the date of purchase. This is calculated as 20% after indexation. Alternatively, if you redeem your investments before three years, you will pay STCG tax as per your tax bracket.

3. Protect Your Money From Inflation

With fixed income securities like FDs, your investments are not protected against inflation. On the other hand, investing in equity funds provides you with the opportunity to earn higher returns, which are often more than the inflation rate and thus protect your portfolio from inflation.

4. Provide You With A Regular Source Of Income

An SWP assures that you receive a fixed and regular income at periodic intervals as per your needs. Other options like monthly plans that pay dividends, the income and periodicity are not fixed. In case there is no appreciation of your investments, you will not receive any income. Moreover, the monthly income amount of other plans is not fixed, as compared to an SWP investment.

A possible disadvantage of an SWP is that your principal may be eroded at some point in time. However, when you judiciously combine investments with income generation, you are able to eliminate the possibility of running out of money.

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