Systematic Withdrawal Plans – How SWP Works? Taxation

A Systematic Withdrawal Plan or SWP allows an investor to withdraw from his/her mutual fund scheme every month on predefined dates. This withdrawal could be a fixed or a variable amount. It could be made on an annual, semi-annual, quarterly, or even monthly basis.

What is a Systematic Withdrawal Plan?

A systematic withdrawal plan allows you to redeem your investment from a mutual fund scheme in a phased manner. Unlike lump sum withdrawals, SWP enables you to withdraw money in instalments. It is quite the opposite of a systematic investment plan (SIP).

In an SIP, you channel your bank account savings into the preferred mutual fund scheme. Whereas in an SWP, you direct your investments from your mutual fund plan to your savings bank account. 

Systematic withdrawal plans allow you to customise the cash flow as per your requirements. You can also choose to either withdraw just the capital gains on your investment or a fixed amount. This way, you will not only have your money still invested in the scheme, but you will also be able to access regular income and returns. The money that you withdraw can either be used to reinvest in some other fund or can be retained by you in the form of cash.

Why Do I Need a Systematic Withdrawal Plan?

You may know that the market fluctuations directly impact your mutual investments. Meaning, the changes may affect the fund NAV adversely. Especially when an individual is approaching a goal, the fund returns can erode if not withdrawn on time.

So, with the help of an SWP, you can time your withdrawals as per your financial needs. If your goal requires being funded in a phased manner, you may opt for an SWP. It will ensure the availability of the funds at the right time. This way, your goal accomplishment may not get delayed owing to a cash crunch arising due to an adverse development in the market.

An SWP also helps investors who want a second source of income in addition to their salary. With this plan, you, as an investor, can create a regular flow of income from your investments. If you seek to have periodic incomes for your travel or other needs, this is a great way to meet them.

Why Is the Systematic Withdrawal Plan a Good Investment Option?

There are two major reasons why this is a wise investment strategy. Firstly, these withdrawals, which are effectively redemptions, are not subject to tax deductions at source (TDS).

The capital gains, though, are taxed on the withdrawn amount. You may also opt for setting up your withdrawal in such a manner that you only draw the gains made on your investment. This keeps your capital invested while, at the same time, you enjoy the gains at a regular interval.

The Withdrawal Options

With the fixed withdrawal option, you can access a specified amount from your investment on either a monthly, quarterly, bi-annually or annual basis. With the appreciation withdrawal option, you may withdraw only the appreciated amount at the intervals you prefer.

How Does a Systematic Withdrawal Plan Work?

When you choose a systematic withdrawal plan, it affects your mutual fund account as well. It is important to note that an SWP is not the same as opening a fixed deposit account in a bank where you receive monthly interests.

With a fixed deposit, the corpus value is not impacted when you withdraw the interest amount. However, in the case of a systematic withdrawal plan in mutual fund schemes, the value of your fund is reduced by the number of units you withdraw. Also, it may be the case that you have withdrawn your capital invested if your investment has not earned any dividends. 

Example:

Imagine you have 8,000 units in your mutual fund scheme, and you wish to withdraw Rs 5,000 every month through an SWP. Let us assume the net asset value (NAV) of the scheme is Rs 10. The withdrawal of Rs 5,000 from this scheme will mean that 500 units are being sold, which is Rs 5,000/NAV of Rs 10. The remaining units in your mutual fund post this withdrawal will be 7,500 units (8,000-500). 

At the start of the next month, if the NAV of your scheme increases to Rs 20, then the withdrawal of Rs 5,000 would mean selling 250 units, which is Rs 5,000/NAV of Rs 20. The mutual fund would be left with 7,250 units post this withdrawal (7,500-250). So, with each withdrawal, your mutual fund will see a decline in its units. At higher NAVs, you may redeem fewer units to fulfil the cash requirements. Conversely, as the NAV falls, it would have the opposite effect, requiring the redemption of more units. An essential aspect of benefiting from this plan and making the most of it is planning the SWP, keeping in mind your needs and end goal. It can have a detrimental effect on the value of your fund if you go for unplanned withdrawals.

Tax Implications of Systematic Withdrawal Plans

The redemption via an SWP is subject to taxation. In the case of debt funds, if your holding period is less than 36 months, then the capital gains realised will be added to your overall income and taxed according to your income tax slab rate. If the holding period is longer than 36 months, then the capital gains are considered ‘long-term’ and taxed at 20% after indexation.

In the case of equity funds, if your holding period is less than one year, then the capital gains realised will be taxed at the rate of 15%. On the other hand, if the holding period is more than one year, then you realise long-term capital gains, which are taxable at 10% without indexation.

An open-ended fund gives you the option of redeeming the investment or modifying it at any time. To know more about open and close-ended funds, visit ClearTax.