What Is Systematic Withdrawal Plan in Mutual Funds?

Do you know you can earn a fixed income every month by investing in a mutual fund? Just like your salary, a systematic withdrawal plan (SWP) can help you earn a regular income, whether you are planning for retirement or need funds for your children.

SWP is primarily designed for those seeking a steady income stream. Let us understand the concept of SWP in mutual funds, its benefits, and how it works.

What is a Systematic Withdrawal Plan?

An SWP allows investors to redeem their returns on mutual fund investments systematically. Unlike the systematic investment plan (SIP), you can redeem your returns on a monthly, quarterly, or yearly basis.

This method of mutual fund investment provides financial stability and cash flow to the investors. Understanding SWP and its features in a mutual fund can help investors make a sound financial decision.

It allows you to redeem consistent returns rather than withdrawing a larger lump sum amount, which can be risky. This not only manages your finances, but also allows your investments to grow over time.

Essential features of SWP

Now that you know what is systematic withdrawal plan, you should have a look at its key features:

1. Flexibility

   SWP in mutual funds offers flexibility to investors by allowing them to select the amount, frequency, and date to receive regular income from an SWP. They are also allowed to stop and modify it whenever they want.

2. Capital Appreciation

   SWP offers capital appreciation in the long run since the regular withdrawal of funds is lower than the returns earned from the investment. You can also reinvest some portion of the withdrawal fund into your investment corpus.

3. Regular Income

   SWP gives you a steady income from your mutual fund investment. Investors who are retirees or who need finances to meet regular needs can invest in SWP.

How Does an SWP Work?

An SWP in mutual funds works just the opposite of the SIP. You will receive a fixed amount every month, quarter, or year on a pre-decided date.

Let us understand how an SWP works with an example. Suppose you have invested INR 2 lakh in a mutual fund scheme for 2 years. You have decided to withdraw INR 10,000 per month. After 2 years, your investment corpus will reduce by INR 10,000 every month and be paid to you.

After redeeming the specified number of units from the mutual fund’s holdings, the fund manager transfers the corresponding amount to an investor’s bank account. The process continues until an investor stops their SWP.

3 Key Benefits of Systematic Withdrawal Plans

1. Disciplined Withdrawal

   SWP in mutual funds allows for a systematic and disciplined approach to withdrawing funds from mutual fund investment plans. For instance, these small withdrawal amounts do not allow you to withdraw large sums due to the panic created by a bearish market.

2. Tax Benefits

   The SWP also helps you avail tax benefits from the Income Tax Act of 1961. In the SWP investment plan, long-term capital gains (LTCG) above INR 1.25 lakh in a fiscal year are taxed at the rate of 12.5%. However, you do not have to pay any tax if the LTCG does not exceed INR 1.25 lakh in a financial year.

   Using an SWP, you can set up your withdrawals in such a way that your returns do not exceed the LTCG threshold of INR 1.25 lakh in a year, and avoid paying taxes.

3. Rupee-Cost Averaging

   SWPs also allow you to avail the benefit of rupee-cost averaging. It redeems fewer units in a bullish market. Conversely, SWPs redeem more units in a bearish market. These strategic plans average the returns and protect investors from losing a huge amount of money by redeeming funds at the wrong time.

Who Can Start a Systematic Withdrawal Plan?

Every individual with a Demat account can start SWP in mutual funds. However, people with certain needs may enjoy the benefits of an SWP to the fullest. Here are some of them:

1. Looking for Capital Protection

   If you are a risk-averse investor and can tolerate a moderate to low risk, you can invest in SWP with large-cap mutual funds or any other low-risk funds. This helps you receive only the capital gain, while your initial investment will remain at almost zero risk.

2. Looking to Create Their Pension

   If you do not have any pension earnings, you can create one by investing the total corpus in mutual funds via SWP. This allows you to earn regularly just like a pension. Since you can create your own, you do not have to wait for retirement to get a pension.

3. People in High Tax Bracket

   Since there is no Tax Deducted at Source (TDS) on capital gains, SWP can be useful for investors who are in a high tax bracket. In addition, the capital gains from equity-based funds carry a moderate tax.

Final Thought

SWP in mutual funds is a smart way to manage your investments while providing regular returns. This flexible and tax-efficient investment option can help you meet your financial needs. Understanding the benefits of SWP allows you to achieve financial stability.

If you are new to mutual funds and want to start an SWP, then download the PL Capital application and invest in its partnered mutual fund schemes. PL not only focuses on mutual funds, but also provides monthly performance and reports.

Frequently Asked Questions

1. Is SWP better than FD?

SWP can be a better investment option for investors looking for a steady income and accepting fluctuating returns. On the other hand, FD can be a better option for those who want guaranteed returns and lock money for a particular period.

2. Is SWP risk-free?

No SWP in mutual funds is risk-free. Although it provides regular income, it is subject to market risks, including tax implications.

3. Does SWP require tax payments?

Yes, you have to pay capital gains tax on SWP withdrawals. You are subject to paying tax only if you gain from an SWP. You need to pay long-term capital gains (LTCG) and short-term capital gains (STCG) taxes in SWP based on the specific holding period of the units.

4. Which is better between SWP and SIP?

It depends on your investment goals and financial needs since both have unique benefits. SWP is great for generating regular income from mutual fund investments. Contrarily, an SIP is ideal for generating returns by making regular investments.