SIP is a common strategy and known to most investors. But do you know how you can systematically withdraw your money when you need it?
Mutual funds are an excellent means of creating long-term wealth. Systematic Withdrawal Plan (SWP) is one of the best ways to withdraw from mutual funds. A Systematic Withdrawal Plan permits investors to withdraw from their mutual funds on a date which is established beforehand. The withdrawal is done each month. The amount of withdrawal can either remain the same every month or change with each month. Moreover, the investor can withdraw every year, half year, every quarter or each month. SWP enables investor to withdraw money in installments, instead of a lump sum withdrawal. It is exactly the opposite of Systematic Investment Plan (SIP). In SIP, the investor can convert money lying in the savings bank account to an instalment in the chosen scheme of mutual fund. On the contrary, in SWP, the investor can transfer his existing investment in a mutual fund scheme to his saving bank accounts. It is a strategy for dealing with fluctuations of the market.
How do SWP works?
Cash flow can be customized as per the need of the investors with the Systematic Withdrawal Plan. The capital gains which are incurred on investment can either be withdrawn or a lump sum amount which is fixed can be withdrawn, depending on your choice. This means that you not only invest your money in the scheme of mutual fund, but also have access to periodic income and good returns. You can reinvest the money in other types of funds or can retain the money that you have withdrawn. You may be aware that your mutual investment always faces changes in the market. It implies that these changes can adversely affect the fund Net Asset Value (NAV).
Particularly when a person reaches a goal, the returns of the fund can be eroded if you don’t withdraw it timely. You can therefore schedule your withdrawals according to your financial needs with the assistance of SWP. If the goal that you have needs to be financed in phases, you can choose SWP. Choosing SWP will guarantee that the funds are available at the appropriate moment. Hence, the achievement of the goal is not be postponed, due to cash crunch. Along with the salary that you get from being employed, SWP supports those investors who need a second income. With this scheme, an investor can generate regular flow of income from the investment.
This is an excellent way of setting this provision if you are seeking to have regular source of income for your different personal needs. You should design the scheme in such a manner that the money is available when you need it the most. It is a wise withdrawal strategy because of two primary factors. The first factor is that the withdrawals, also known as redemptions, do not incur TDS. However, the capital gains earned would be taxed on the amount which is withdrawn. Secondly, you can also choose to withdraw in a manner that you withdraw only the returns which are generated on the investment.
This keeps your investments intact along with giving you returns at periodic intervals. You can choose to avail a specific amount on a quarterly or monthly basis from your investment with a fixed withdrawal option. Also, with the option of withdrawing only the returns, you can avail only the returns on a monthly or quarterly basis.
It also impacts your Mutual Fund balance when you choose a SWP. It should be noted that SWP is not identical to investing in a fixed deposit scheme where monthly interests are received. If you withdraw interest on fixed deposits, the value of the corpus would remain the same while the fund value is reduced by the units that have been withdrawn in case of a Systematic Withdrawal Plan of the mutual fund scheme.
Let us understand with an example
Imagine in your mutual fund account, you have 8,000 units and you want to withdraw every month Rs. 5,000 through Systematic Withdrawal Plan. Let’s suppose that Rs. 10 is the scheme’s NAV. If the withdrawal of Rs. 5,000 has been made from the scheme, this means that you have withdrawn 500 units (Rs. 5,000/Rs.10). After this withdrawal, the total 7,500 units (8,000-500) are left in your mutual funds. If the NAV of scheme rises to Rs. 20 at the beginning of the next month, then 250 units (Rs. 5,000/Rs. 20) would be withdrawn from the mutual fund holdings. So, the remaining units which will be left to the mutual fund will be 7,250 units (7500-250).
Therefore, every withdrawal will see your mutual fund’s units decline. With higher NAVs, less units can be redeemed to meet the requirements of cash. In contrast, if the NAV falls, there would be an opposite effect and would require more units to be redeemed. The redemption may be taxable through a Systematic Withdrawal Plan. For debt funds, when the holding period does not exceed 36 months, the amount which has been withdrawn will be part of the income. It is then taxable according to the slab of your income. When holding period exceeds 36 months, 20% tax with indexation will be levied on capital gains of long-term duration. For equity funds, when the investment period is lower than a year, 15% tax will be levied on the withdrawn amount and if investment tenure is greater than a year, then 10% tax without indexation shall be imposed on capital gains of long-term duration.
How to apply for SWP?
The following investors can apply for Systematic Withdrawal Plan through the following ways:
- Existing Investors: Talk to your financial advisor/dealer and tell them that you want fixed amount. Complete the SWP form and send for processing to the Asset Management Company (AMC)/ Registrar.
- New Investors: You can opt for SWP in the existing scheme, once you have invested in mutual funds. In the application form, mention the amount you want on monthly basis and then send it for processing to the AMC/Registrar.
There is a common misconception that only traditional products and not market linked products like mutual funds can provide regular cash flows at certain rate. An investor is able to opt for the Systematic Withdrawal Plan or SWP for periodic cash flows, particularly in case of debt mutual funds.
In case of equity counterparts, they are comparatively less volatile. Within debt funds, SWP would comparatively have better places for short maturity debt funds and accrual funds. As per your financial plan, if you invest an adequate amount in MFs, then SWPs may be set up for regular income during your retirement years.
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