A Systematic Withdrawal Plan (SWP) is a feature offered by mutual fund companies. It allows investors to withdraw a fixed amount of money from their investments on a regular basis. This option benefits those who need a steady income stream, such as retirees or those looking for additional financial support.
One of the key features of an SWP is its flexibility. You can withdraw a fixed amount regularly or only take out the gains (profits) from your investment while keeping your original investment amount intact. It must be noted that the withdrawals are made by selling a portion of your mutual fund units, and the money is then transferred to your bank account.
Moreover, an SWP helps you to manage market fluctuations better, as you’re not taking out a large amount all at once. This way, through SWPs, you can create a reliable income stream while keeping your investment working for you.
What is a Systematic Withdrawal Plan?
A Systematic Withdrawal Plan is an investment redemption strategy that is commonly used in mutual funds. Here, you withdraw only a fixed portion of your mutual fund corpus at periodic intervals. You can decide the percentage of the corpus that you want to redeem as well as the frequency at which you want to redeem it.
This is different from traditional investment redemption, where you sell all your mutual fund units at one go and withdraw the entire corpus as a lump sum. When you opt for a SWP in mutual funds, you can choose to withdraw a fixed number of units at periodic intervals or a fixed percentage/amount of your capital. For example, say you have a mutual fund corpus of Rs. 5 lakhs, and the fund earns 12% returns on average per year. If you implement a SWP to withdraw Rs. 50,000 annually, then, at the end of the first year, the fund balance will be Rs. 5,10,000 (i.e. a growth of Rs. 60,000 or 12% coupled with a withdrawal of Rs. 50,000).
How does a SWP work?
A Systematic Withdrawal Plan is quite easy to set up nowadays. You can instruct your preferred mutual fund house or stock broker to set up a SWP for your investments from a specified date. You must also choose the withdrawal amount and the withdrawal frequency. Thereafter, the corpus built up over the investment tenure will be withdrawn systematically as per your instructions and credited to the bank account provided.
Let us discuss an example to further understand how SWPs work. Suppose you have a total investment of Rs. 10 lakhs in mutual funds, divided into 1,00,000 units of Rs. 10 each. You decide to redeem Rs. 5,000 per month. Here is how your SWP will work out during the next six months.
Month |
NAV per unit |
SWP Amount (Rs.) |
Units Redeemed |
Units Left |
Month 1 |
10.30 |
5,000 |
485 |
99,515 |
Month 2 |
9.70 |
5,000 |
515 |
99,000 |
Month 3 |
11.50 |
5,000 |
434 |
98,566 |
Month 4 |
12.30 |
5,000 |
406 |
98,160 |
Month 5 |
10.60 |
5,000 |
471 |
97,689 |
Month 6 |
9.80 |
5,000 |
510 |
97,179 |
Key features of a Systematic Withdrawal Plan (SWP)
- Regular Withdrawals: SWP allows you to withdraw funds at scheduled intervals, ensuring a steady flow of income.
- Flexibility: You have the freedom to decide the withdrawal amount, frequency, and the duration of the plan based on your financial needs.
- Compounding Advantage: Since not all units are withdrawn at once, the remaining investments continue to grow, benefiting from compounding returns.
- Disciplined Strategy: SWP promotes a structured withdrawal method, helping to manage funds more effectively and preventing rapid depletion of your investment.
- Rupee-Cost Averaging: Regular withdrawals may help smooth out the cost of your investments, reducing the effect of market fluctuations over time.
Advantages of a Systematic Withdrawal Plan
If you are unsure about choosing between a lump sum withdrawal and a SWP in mutual funds, let us explore the benefits of the latter. This will help you make an informed choice.
Suitable in a bull market
If the market is bullish at the end of your investment tenure, a SWP can help you capitalise on the upward price movements while still redeeming a part of your corpus. The mutual fund units that are yet to be redeemed will continue to accumulate and appreciate because of the bullish run.
Supports disciplined withdrawals
Choosing to withdraw small sums periodically can foster investment discipline. It prevents impulsive lump sum withdrawals and helps you avoid spending the entire capital in one go. Since you only have access to your funds in small amounts, you can use the money more prudently.
Gives you a predictable income
Opting for a Systematic Withdrawal Plan can give you access to a steady stream of income. This can act as supplementary income if you are still working. Alternatively, it can help replace a part of your primary income when you retire. All the while, your unredeemed mutual fund investments may continue to grow based on the market movements.
It helps avoid timing the market
If you choose to make a lump sum withdrawal, you need to study the market and pinpoint the ideal time to exit your mutual fund investments. If the market rises after the mutual fund redemption, you may suffer from seller’s remorse. Timing the market can also be tricky and incredibly challenging. By choosing an SWP instead, you avoid all this hassle.
The benefit of rupee cost averaging
Rupee cost averaging is a key strategy in investment, particularly relevant to Systematic Investment Plans (SIPs) and Systematic Withdrawal Plans (SWPs). This approach involves investing or redeeming a fixed amount at regular intervals, regardless of the market conditions. The primary benefit of rupee cost averaging is its ability to mitigate the impact of market volatility, thereby optimising returns over time.
In the context of SIPs, rupee cost averaging allows investors to purchase more units when prices are low and fewer units when prices are high. This results in a lower average cost per unit over the investment period. Consequently, when the market eventually rises, the investor can benefit from significant gains as the value of their accumulated units appreciates.
Similarly, SWPs benefit from rupee cost averaging through the systematic redemption of mutual fund units. By redeeming a fixed amount regularly, investors are likely to sell their units at various price points, both high and low, over time. This strategy helps in averaging out the sale prices, potentially leading to a higher overall average sale price per unit during favourable market phases. As a result, the net returns for the investor can increase, providing a more stable and potentially higher income stream.
Rupee cost averaging also reduces the emotional impact of market fluctuations. Investors are less likely to make impulsive decisions based on short-term market movements, as their investment or redemption is automated and consistent. This disciplined approach can lead to more rational investment behaviour and better long-term results.
Moreover, rupee cost averaging is particularly beneficial for those with a long-term investment horizon. Over time, the effects of market volatility tend to smooth out, and the average cost per unit can become advantageous. This strategy is well-suited for investors seeking to build wealth steadily without the need for constant market monitoring or timing the market.
In summary, rupee cost averaging, whether through SIPs or SWPs, provides a practical and effective way to manage market volatility, enhance potential returns, and promote disciplined investment behaviour. It is a valuable strategy for achieving long-term financial goals with reduced risk.
Tax Benefits
When you redeem your mutual fund holdings via a SWP, you may earn capital gains on the redemption. These capital gains are taxed based on the type of mutual funds redeemed and their period of holding. W.e.f July 23, 2024, the classification of mutual fund profits as long-term or short-term capital gains and the taxation rules involved are as follows:
Type of Mutual Fund |
Short-Term Capital Gains (STCG) |
Long-Term Capital Gains (LTCG) |
Taxation |
Equity funds and aggressive hybrid funds that invest over 65% in equity |
If held for less than 12 months |
If held for 12 months or more |
STCG is taxed at 20% and LTCG is taxed at 12.5% without indexation benefits |
Debt funds and conservative hybrid funds that invest 35% or less in equity |
No effect of the holding period on the classification or taxation of the capital gains earned |
All capital gains are taxed at the income tax slab rate applicable to the investor |
|
Other funds that invest more than 35% but less than 65% in equity) |
If held for less than 36 months |
If held for 36 months or more |
STCG is taxed at the income tax slab rate applicable and LTCG is taxed at 20% with indexation benefits |
Who can benefit from a systematic withdrawal plan (SWP)?
For those seeking a regular source of secondary income
If you are looking to create an additional income stream from your long-term investments, a Systematic Withdrawal Plan (SWP) could be an ideal solution. By investing in mutual funds and setting up an SWP, you can withdraw a fixed amount of money at regular intervals, such as monthly or quarterly. This can help you manage the rising cost of living and ensure a steady flow of secondary income.
For those focused on capital protection
Risk-averse investors can benefit from SWPs by choosing moderate or low-risk mutual fund schemes. With this approach, you can withdraw only the capital gains, leaving your principal investment relatively untouched. For example, if you invest in an arbitrage fund, you can receive the capital appreciation regularly through an SWP, while your initial investment remains at almost zero risk.
For those wanting to create their own pension
If you don't have a pension plan, you can create your own pension using an SWP. By investing your retirement corpus in mutual funds that match your risk profile, you can withdraw a regular income at a frequency that suits you. This way, you can start an SWP upon retirement and enjoy a steady income stream, effectively creating your own pension.
For those in a high tax bracket
High-income investors often find SWPs advantageous because there is no Tax Deducted at Source (TDS) on the capital gains. Additionally, the capital gains from equity or equity-oriented funds are taxed at a moderate rate. Gains from debt-oriented funds also benefit from moderate taxation due to the allowance of indexation on long-term capital gains.
Effective uses of a SWP in mutual funds
You can use a systematic withdrawal plan for various purposes such as:
- Pension benefits: You can use the period withdrawal amounts as a substitute for or addition to your pension income after you have retired. The amount withdrawn periodically can help you meet your everyday expenses and ensure that you can maintain the required standard of living even after you retire.
- Securing an additional source of income: Even if you have not retired, having an additional source of income during your working years can be a convenient financial cushion. The periodic income via your SWP can help you pay off your debts faster or add to your household income in other ways.
- Capital protection: Withdrawing your mutual fund investments through a SWP helps protect your capital during the withdrawal phase. You can move the remaining corpus to a stabler option like arbitrage funds or debt funds and ensure that the wealth created remains intact even during the withdrawal period.
How SWP and the 4% rule can ensure a comfortable retirement
The 4% rule is a popular guideline for retirees seeking to determine how much they can safely withdraw from their retirement savings each year. This rule suggests that withdrawing no more than 4% of your retirement corpus annually can help ensure your savings last throughout your retirement.
How the 4% Rule Works
- Calculate Your Retirement Corpus: Estimate your total retirement savings, including contributions from various sources like pensions, investments, and savings accounts.
- Determine Your Annual Withdrawal: Multiply your retirement corpus by 4% to determine your annual withdrawal amount. For example, if your retirement corpus is Rs. 35,00,000, your initial annual withdrawal would be Rs. 1,40,000.
- Adjust for Inflation: To account for rising living costs, increase your annual withdrawal by the expected inflation rate each year. For instance, if the inflation rate is 3%, your withdrawal in the second year would be Rs. 1,44,200.
Example
Age |
Year |
Start Balance |
Withdrawal |
Gain |
Balance |
Cost of Living |
60 |
1 |
Rs. 35,00,000 |
Rs. 1,40,000 |
Rs. 2,00,000 |
Rs. 35,60,000 |
0.03 |
70 |
11 |
Rs. 42,00,000 |
Rs. 1,68,000 |
Rs. 2,50,000 |
Rs. 43,82,000 |
0.03 |
80 |
21 |
Rs. 51,00,000 |
Rs. 2,04,000 |
Rs. 3,00,000 |
Rs. 52,06,000 |
0.03 |
90 |
31 |
Rs. 60,00,000 |
Rs. 2,40,000 |
Rs. 3,50,000 |
Rs. 61,10,000 |
0.03 |
While the 4% rule provides a helpful starting point, it's essential to consider these factors and adjust your withdrawals accordingly to ensure a comfortable and financially secure retirement.
Some mutual funds you can invest in:
- Quant Absolute Fund Growth
- ICICI Prudential Equity & Debt Fund
- Canara Robeco Equity Hybrid Fund
- DSP Equity & Bond Fund
- SBI Equity Hybrid Fund
Should you opt for a SWP?
A Systematic Withdrawal Plan may not be suitable for all investors. However, it may be a good choice for you if you:
- Need a regular stream of income
- Want to manage market risks using regular withdrawals
- Want to maintain some investment exposure while also withdrawing a part of your corpus
- Are looking for flexibility in your investment withdrawals
- Want to transition smoothly from investments to redemption
- Want to continue to benefit from a bull market
Tips before starting your SWP journey
Before you start a Systematic Withdrawal Plan, it's important to assess your financial needs carefully. Specifically, consider factors like inflation and the need for emergency funds. As a tip, do not base your decision solely on how well an investment has performed in the past. Instead, pay attention to current market conditions that could impact your future returns.
Additionally, consider whether you should choose the growth or dividend options for your investments. Be aware that this choice affects how much money you make and the taxes you pay. By picking the right option based on your financial situation and tax obligations, you can maximise your returns from the SWP.
Key takeaways
- A systematic withdrawal plan (SWP) is a strategy to redeem your mutual fund investments systematically, by withdrawing a small portion of the corpus over an extended period.
- It helps preserve the capital earned over the investment tenure and allows you to earn further returns on the balance corpus during the SWP period.
- The amount you need to withdraw depends on your post-retirement financial requirements and the other investments you have accumulated by then.
Conclusion
Now that you know the meaning of SWP in mutual funds, how it works and why it is beneficial, you can decide whether this strategy is suitable for you. This withdrawal strategy is very similar to the Systematic Investment Plan (SIP), in which you invest in mutual funds at regular intervals. If you are just getting started with mutual funds, a SIP calculator can help you create an effective investment strategy.
You can also check out the 1,000+ mutual fund schemes available on the Bajaj Finserv Mutual Funds Platform. To find the scheme that is best for you, you can compare mutual funds, understand their features and benefits and make an informed decision. If you have a large amount of liquid capital in hand, you can even make a lump sum investment in any mutual fund.
