What is a Systematic Withdrawal Plan?
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Are you planning to take a sabbatical from work? Or maybe you are thinking of quitting your full-time job to start something of your own? Or maybe retirement is just around the corner? Then obviously your main concern right now will be to replace that steady and regular income inflow so that your budget and finances don’t go haywire.
Don’t fret, there is a perfect readymade solution for all your regular cash flow worries, called the Systematic Withdrawal Plan.
Just like SIP or STP, SWP is a facility provided by mutual fund houses to their customers. As the name suggests, Systematic Withdrawal Plans allow you to withdraw or redeem money from your existing mutual fund investment(s) periodically and regularly and as per your need. In other words, SWP is the reverse of SIP. Where in SIP you place an instruction for systematic and regular transfer of money from your bank account into your selected fund, in SWP you place an almost similar kind of instruction to withdraw from your fund back into your preferred bank account.
How does an SWP work?
Setting a Systematic Withdrawal Plan up is quite simple. just provide the following instructions to your fund house:
- Frequency of withdrawal – monthly, quarterly, annually
- Amount of each withdrawal
- The date on which you want to receive funds in your account
- Delivery instructions for the money – bank account you want to get your funds transferred into
Once you give these details your SWP will get established and you will start receiving the desired amount of money automatically in your bank account as per your instructions.
Let’s say you have 50,000 units of a mutual fund scheme Edelweiss Prudent Advantage Fund in your portfolio and the NAV is currently ₹20. Now if you instruct the mutual fund house Edelweiss that you want ₹10,000 deposited into your account every month from today, they will redeem 500 units and transfer ₹10,000 into your account (20*500 = 10000). At the end of the first month you are left with 49,500 units.
Next month say the NAV was ₹22.2 Edelweiss will redeem 450 units and transfer the amount in your bank account. At the end of 2 months you are left with 49,050 units & so on.
Advantages of SWP
- Guaranteed cash flow with inflation protection
Systematic withdrawal plans remove the element of uncertainty. It is a given that you will receive the desired amount in your bank on the desired date without fail. You can even plan your budget based on that fixed amount of cash flow. No other option like Monthly Income Plans or Dividend Plans provide such a regularity or guarantee. While the interest earned from bank deposits are certain, they are not tax efficient and if you take inflation into consideration the income earned in the form of interest is very minuscule. Therefore SWP allows you to earn higher returns and a regular guaranteed cashflow.
- Exit Cost Averaging
Just like in SIP you get rupee cost averaging, in SWP you get exit cost averaging or sales price averaging. Your investment continues to earn returns even when you start withdrawing what you need. This means that your initial invested corpus is serving a dual purpose of providing you a regular income while earning returns on the still-invested amount. Let’s understand this with help of following table which shows withdrawals for 3 consecutive months using the example from above:
NAV on the 10th of every month Units redeemed Remaining units Remaining Corpus (C*A) ₹20 500 49500 ₹9,90,000 ₹22 450 49050 ₹10,79,100 ₹21 476 48574 ₹10,20,054
It’s clear from this table that although you’ve redeemed ₹30,000 from your initial deposit of ₹10 Lakhs your remaining corpus is still above ₹10 Lakhs at the end of 3 month. This is due to the fact that the NAV was also rising in those months of withdrawal.
You can change the SWP details any time you like. You can start, stop, increase or decrease the amount of withdrawal via SWP as per your need – Your new venture is off to a good start? Reduce your monthly SWP by half!
Also, you can even withdraw the rest of the money any time you want even if you have opted for SWP. There is absolute flexibility – you can decide how to manage your money, it’s your call always.
How long can an SWP last
This depends on your initial invested corpus amount, rate of return earned by your investment and the amount of withdrawal. The bigger your withdrawal, the faster will be the depletion. But it’s still possible to make it last as long as possible, by smart planning. If your withdrawal rate is less than the growth of fund you can enjoy benefit of SWP for a long time. For example: If your investment is earning say 12% return per annum and you withdraw only 6-7% of the invested corpus annually, you can use your one time investment for a long time.
Things to keep in mind
- SWP facility is not available for schemes under lock-in period. You can also not start SWP in schemes where SIP is going on.
- Units are redeemed in first in first out basis.
- There are no particular funds or schemes considered which can be termed as best or good for SWP. Since Systematic Withdrawal Plan is not a product but a method or tool used for redeeming the money, it can be employed to any preferred or suitable fund based on one’s goal or risk profile. But as discussed above SWP works best in a rising market, but unfortunately market does not always rise it also goes downhill sometimes. Therefore, I would suggest opting for a equity linked hybrid fund, instead of pure equity or debt fund. Hybrid fund will give higher returns than debt fund, and will also reduce the impact of falling market as compared to equity funds.
- Taxation in case of SWP is the same as of redemption from any mutual fund, you are liable to pay STCG tax or LTCG tax based on your fund type and holding period. Therefore it makes sense to plan your investment smartly so that you can enjoy your regular supply of money in a tax efficient manner. It would be wise to stay invested for atleast a year in an equity scheme before starting an SWP. This is because LTCG tax on equity fund is nil after a year. This way you can have your cake and eat it too, i.e. you can pocket all the earnings in regular cash flow way without paying anything in taxes.
- SWP is not always recommended, it should be only used when in need of regular cashflow. When you have a steady stream of income you should opt for SIP or STP and let your investment accumulate wealth for you. Only, when in need of regular inflow of money should you terminate SIP and start SWP.
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