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SWP For Support in the Twilight Years

by Tavaga Invest

Even though not as popular as pensions, an SWP can bring us many benefits

Source: Tavaga Research

The acronym, SWP stands for a Systematic Withdrawal Plan. SWP means a scheme in which investors withdraw from their invested sum at regular intervals. Most often,  we see SWPs in mutual funds. Mutual funds are a pooled investment product, like exchange-traded funds (ETFs). 

How Does SWP Work?

An investor has to select the interval at which they wish to withdraw funds. The intervals selected are usually either monthly, quarterly, or yearly. 

The other criteria to choose is the amount to be withdrawn. It may be a fixed one or a variable one.
We have to remember that as we hold units of an investment fund, SWP redemption would mean a reduction in the volume we hold. Be it a variable or a fixed amount, depending on the current Nav (net asset value), or the unit price, we would be redeeming a portion of the total units held by us when we withdraw.

For example, if we have 25,000 units of an MF, and withdraw Rs 3,000 each month through an SWP, the total units will decrease accordingly. In a month, when the Nav is, say, Rs 25 on the withdrawal day, we would be redeeming 120 units (Rs 3,000/Rs 25). The balance of 24,880 units would be carried forward.

The Nav may rise to Rs 40 the next month, which would mean we redeem 75 units, leaving our total units at 24,805.

The number of units at each redemption will vary with the Nav. There is an inverse relationship between the Nav and the number of units. If the Nav goes up, then the number of units redeemed will go down and vice versa.

Choosing an SWP

A definitive answer to the query, “Which mutual fund is best for SWP” is any mutual fund that offers a higher rate of return than the amount withdrawn under SWP. 

Only if the rate of withdrawal under SWP is less than the rate of return on an MF, will an SWP make sense because the remainder will be able to earn capital appreciation after the month’s withdrawal.

What is an SWP Calculator?

An SWP calculator, many of which are found on the Internet, will give us quick estimates of the amount we will be left with after investing a certain sum of money for a specified rate of returns, and withdrawing at given intervals from it. 

SWP calculators help us in determining if, at a given rate of return and a period of time, a withdrawal sum will leave behind enough remainder to earn us returns or not.

Steps to Actually Initiate an SWP

  1. We need to select an MF scheme based on our risk appetite. Before choosing a distributor, we have to make sure if the SWP facility is provided by them or not. 
  2. After selecting the scheme, we need to select a distributor, which in turn applies on our behalf to the fund house, issuing the MF, to buy the desired number of units of the selected scheme. We don’t need to have a demat account.
  3. SWP is an option provided by the MF distributor. Not all distributors in India provide the option of SWP. Karvy Broking, Motilal Oswal Financial Service are some of the distributors that provide us with the option of SWP. 
  4. The process to initiate SWP begins after we have invested in an MF scheme. One-time SWP instructions need to be given to the MF distributor. For example, an instruction may be issued for redeeming Rs 5,000 worth of units on the second day of every month as an SWP. 

What does SWP Mean for its Audience?

The primary target audience for SWPs is those without an active source of income. Many of us may ask, “Is SWP good for retirees?” Retirees and senior citizens form the core audience for SWPs. For what is SWP if not an investment-linked pension plan?

Much like pensions, SWPs provide a regular source of income even for those without actively earning regularly. Of course, for it to work, there needs to be some room for a corpus to build in order to withdraw without hassle.

SWP tax benefits
Source: Tavaga

SWP’s Tax Benefit

SWPs enjoy two tax benefits. One, its redemptions are not subject to TDS (tax deducted at source). Two, if the SWP amount is less than Rs 1,00,000, then capital gains tax (both short-term and long-term) would not be applicable to them. Any amount equalling or above Rs 1,00,000 withdrawn at once is taxed as a capital gain, at  10 percent if withdrawn after one year, or at 15 percent if withdrawn within one year of investing.

However, the second tax benefit is subject to another condition besides the amount withdrawn. It is applicable only for equity MF SWPs. SWPs on debt funds are taxed as a part of income, at the rate of the investor’s income tax slab if redeemed within 36 months. When redeemed after three years, they attract an LTCG (long-term capital gains) tax at 20 percent with indexation benefits (ie. concession in the form of the Nav’s rise marked against inflation.

SWP vs Lump Sum Withdrawal

Tax benefits are not the only perks of SWP. As with SIP (for accumulating wealth), SWP (for redeeming returns) brings us the benefit of rupee cost averaging. 

Rupee cost averaging sees investors buy or sell financial instruments such as MFs worth a fixed amount at regular intervals.

Rather than lump sums, phased buying or selling help in mitigating the adverse effects when the markets are down with the buoyant earnings when the markets are up.

The comparison below illustrates why investor A who withdraws Rs 9,000 in an SWP every month tides over the fluctuations in the market better than investor B who withdraws a lump sum when the Nav is especially low (in June here), losing out on the upturn in the markets. 

Investor B is left with 467 units, lower than investor A’s 474 units that remain still invested.

SWP option

Source: Tavaga Research

Lumpsum withdrawl

Source: Tavaga Research

What is the Difference Between SWP and STP

SWPs regulate our withdrawals or redemptions of MFs. A systematic transfer plan or STP, on the other hand, is a way to transfer invested funds from one MF or pooled fund scheme to another. 

We need to invest a lump sum amount in an MF and then select the option to start an STP. 

STPs come in handy when we wish to shift from an equity MF to a debt MF and vice versa. The reasons for opting for an STP may include the goal-planning, where we try and move our investments from riskier to more sedate instruments as we near our financial goal(s). 

For pooled funds other than MFs such as ETFs, Robo-advisors may be easily programmed to automatically make such tactical shifts en route to our goals, instead of a traditional STP. 

With SWPs, there is no one-size-fits-all. But if chosen right, an SWP may provide financial security in our twilight years. But it should be the only fund source in our retirement planning.

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