Whether or not to opt for SWP in Mutual Funds

Fixed deposits and other conventional investment options are facing a slump, nowadays. This is why looking for avenues that can tide of inflation are imperative. Hence, senior citizen and retirees alike are flocking around Systematic Withdrawal Plans for their mutual fund investments for securing a regular income.

Systematic Withdrawal Plan

SWP is a facility offered by a mutual fund online that allows investors to withdraw or receive a regular payout out of their corpus. These withdrawals are also called redemptions.

Let’s understand SWPs with an example: Mr Sinha is due to retire this year and has an investment corpus of Rs. 10 lakhs. Keeping in mind his current needs, he thinks he would require Rs. 10,000 each month over and above his monthly pension. Hence, he opts for the SWP facility.

If the rate of interest were to be 9% per annum, his fund of Rs. 10 lakhs would, ideally, last for 182 months; or, over 15 years!!

Consider this: If the withdrawn amount is lower than the yearly returns, the fund may even become a continuous, perpetual source of income.

Investors can opt for a Systematic Withdrawal Plan any time after investing in mutual funds. To activate SWP, investors are required to fill a request form with their AMC (Asset Management Company). Information, such as folio number, frequency of withdrawals, first withdrawal date and the respective account in which it has to be credited, has to be shared in this form.

Why Go for SWP?

In comparison to dividend option, an SWP is definitely more reliable, as it provides a fixed sum at pre-decided intervals for a set tenure. Dividends, on the other hand, are not predictable or predefined. Fluctuation is a common factor associated with dividends. As mandated by SEBI, dividends cannot be disbursed from the fund capital, which is why they depend upon the profits generated by the fund. This is not true for Systematic Withdrawal Plans. And, while they offer a fixed income regularly, the value of your funds reduces by the number of units withdrawn.

Keeping in mind that most fixed-income investments don’t offer any protection against inflation, SWPs offer investors an extra edge, especially through equity fund routes. It also gives you the option of modifying your withdrawals at any time.

However, each SWP redemption is subject to taxation. If the fund holding period is less than 36 months, then the withdrawn amount will be considered as a part of an investor’s income. Also, it will be taxed according to the investor’s respective income tax bracket.

On the contrary, if the redemption is made after 36 months, Long Term Capital Gains (LTCG) tax will be levied on the withdrawn amount, which is 20% with indexation and 10%without indexation.

Moreover, no tax deduction at source (TDS) is applicable to these redemptions and only the capital gains are taxed.

However, there is an issue that peeves investors out. Some investors think that opting for SWP may result in loss of the entire capital. If the redemption is more than the yearly returns on investment, the fund will eventually be depleted to the point of exhaustion.

Although this is true, the solution to this problem does exist. However, taking the advice of a financial advisor in this matter is recommended, as the solution may be different for each investor. In some cases, the investment is re-planned and switched in order to keep the returns higher than the redemption.

Experts are of the opinion that SWPs might prevent the capital to build up to an optimum level and erode the corpus in a short time. However, if the allocation to equity is only up to 25%, the chance of this happening is negligible.

A suitable way to do this is splitting the capital between debt and equity in the ratio of 75:25. This mix is expected to yield 8 to 10% returns annually for a period of 5 years. The ideal redemption from this fund would be any amount lower than 8%.

Final Thoughts

While it is important for investors to choose their investments carefully, they must keep an eye out for tax laws. Though SWPs have benefits that surpass those of conventional fixed-income investment instruments and dividend option in mutual funds, it can also lead to capital erosion. Consulting an advisor in order to make a suitable investment plan, using a mutual fund calculator for calculating returns and diversifying the portfolio later is highly recommended.

The bottom line is that capital management in SWPs is possible, provided that enough precautionary measures are taken.