Enjoy steady income on your investments with Systematic Withdrawal Plans

"Beware of little expenses; a small leak will sink a great ship," said statesman Benjamin Franklin. But, if Franklin had the option of SWPs (Systematic Withdrawal Plans) in his day, the great man may have been a little less worried about his daily expenses.

This little known aspect of the investment option allows you to not only invest but have a steady income along with your investments.

"SWP is the exact opposite of SIP (Systematic Investment Plan)," says Harsh Jain - COO & co-founder, Groww. In SWP, you withdraw a fixed amount of money from a mutual fund at regular intervals. If you have a large amount of money invested in a mutual fund, you can withdraw it gradually every week or month. "This way you can have a regular income," says Jain.

"SWP is a method for investors to redeem their mutual fund units," says Archit Gupta, founder & CEO, ClearTax. An SWP allows investors to redeem their investment in a phased manner or installments. SWPs allow investors to withdraw their mutual fund investments periodically, and the frequency can be monthly, bi-monthly, quarterly, or annually, similar to investing in a systematic investment plan (SIP).

With SWPs, investors can customise their cash flow from their mutual fund investment to suit their requirements. SWPs channelise investments from the mutual fund scheme to investors' bank account. "SWPs are seen as a useful tool to deal with market fluctuations," says Gupta.

So what sets your SWP apart from your regular dividend-paying plans?

"A significant benefit is of assured regular income," says Jain. In the case of dividend mutual funds, the fund manager can choose to skip paying a dividend if he feels the conditions make it necessary. In the case of SWP, you will definitely get your regular income as long as there is money in your mutual fund.

"SWP is generally done through debt funds, whereas dividend-paying plans can be either equity or debt," says Deepak Chellani, head - third party products, Prabhudas Lilladher.

"SWP payments are made from the capital invested while in dividend plans your dividend paid out is from the gains made on the invested capital," says Gupta. Also, the payout amounts through SWP are fixed while it varies when it comes to a dividend-paying plan.

Each SWP withdrawal results in capital erosion, whereas the capital remains the same in a dividend-paying plan.

So, why aren't such SWP plans better known in the investing world in India?

Experts opine that only 8% of the population is considered as investors, and that includes LIC investments, which are actually insurance policies rather than investments. Actual investors are less than 2% of the population. "A handful are aware, I feel that perhaps 60% would be aware of SWP," says Chellani, who feels that around 0.6% of the Indian population would be aware of SWPs.

You can start an SWP online any time after you invest in a mutual fund. However, since you redeem your fund units in an SWP, it is advisable to keep the exit loads and other capital gains considerations in mind before you actually start an SWP. The maximum time till which an SWP can run is till you have completely redeemed your holdings.

You can withdraw through SWPs whenever you need them. You need to inform your fund house. You can start or stop SWPs anytime, as per your requirement. Remember, if your investment has not accumulated gains, then you can withdraw from the capital invested.

So, what kind of people should go in for SWPs?

"SWPs channelise investments from the mutual fund scheme to investors' bank account," says Gupta. SWPs are a useful tool to deal with market fluctuations.

"SWP can be effectively used for goals like retirement where a fixed payout is scheduled every month from your investments," says Radhika Gupta, CEO, Edelweiss AMC, expressing her personal opinion.

"Investors who seek steady income, generally fall in the retirement category or those who are on the verge of retirement," says Chellani. Thus, they are risk-averse and would like a regular payout.

Chellani advices that in such a scenario, it's best to invest a lumpsum amount in debt funds (accrual) to reduce volatility and then structure an SWP based on the monthly requirement.

Do remember that in the accrual option of your debt fund that in turn is funding your SWP in the interim, one earns an interest that is higher than a bank FD or a savings account. Also, these funds are highly liquid compared to a bank FD.

What to watch out for in your SWP

"If markets are down and you are not proactive, then your principal gets eroded, and you will not purchase more units when the prices are declining," says Archit Gupta, founder & CEO, ClearTax. Hence, it will hinder your chances of making the most out of the falling markets.

Remember, you are not allowed to initiate an SWP when you have an ongoing SIP.

"One disadvantage of an SWP is the case when the market hits a low and consequently your fund units fall in value," says Harsh Jain - COO & co-founder, Groww. In such a scenario, more fund units would have to be redeemed to meet the monthly income amount you desire. This could potentially deplete your initial investment corpus faster.

SWPs and tax

"There is no flat tax applicable on SWPs, as its just a method of taking out money from a mutual fund," says Harsh Jain - COO & co-founder, Groww.

Taxation depends on the type of mutual fund you have invested in. If in case the SWP is done in an equity mutual fund where the amount had been invested more than a year ago then, LTCG (Long Term Capital Gains) tax is applicable. In the case of LTCG in equity investments, if the total gains in a year are higher than Rs 1 lakh, then a 10% tax is applicable on the part above Rs 1 lakh. If the total annual gains are below Rs 1 lakh, then no tax is applicable. "Please note, gains are the part that is above the amount you initially invested, also known as profit," says Jain.

"The tax treatment of every withdrawal made through SWP is the same as applicable to the redemption of equity or debt funds," says Archit Gupta, founder & CEO, ClearTax. Debt funds withdrawal made within 36 months are taxed as short-term capital gains; tax is applicable as per your income slab. If debt funds are sold after 36 months, investors are levied with long-term capital gains tax at the rate of 20% with indexation benefit.

Other options for regular income

Monthly income fixed deposits schemes: This is apt for those looking to earn a steady income at a fixed rate monthly. Monthly income fixed deposits have tenures of up to 10 years. Investors are allowed to withdraw their capital investment before maturity, but the interest offered on the capital would be paid at a discounted rate.

Post office monthly income scheme (POMIS): The government backs POMIS and is considered as one of the safest investment options in India. Investors can deposit up to Rs 4.5 lakh in a POMIS account while a person can hold a maximum of two POMIS accounts. POMIS offers a monthly payout of interest. These accounts come with a maturity period of 5 years, and premature withdrawals attract penalties on the interest payments.

Senior citizen savings scheme (SCSS): Only senior citizens (60+ years) are eligible for investing in SCSS. Also, employees above the age of 55 years and less than 60 years old, who are retiring on a voluntary retirement scheme, or superannuation plan, are eligible. The SCSS offers a much higher rate of interest than conventional investments such as FD and RD. SCSS has a maturity period of three years and can be extended for an additional three years. The scheme offers quarterly payouts of interest accrued.

Source – ClearTax.