Important Features of SWP

SWP makes benefits or income via redeeming units from the scheme at the specified period of time. The amount of SWP and the scheme NAV on the payout date will be decided via the number of units redeemed to generate this income.

For Example, an investor puts Rs. 100,000 in a mutual fund where the NAV (price per unit) is Rs. 10, so the investor gets 10,000 units. After one year, they start a monthly SWP (Systematic Withdrawal Plan) to withdraw Rs. 1,000 every month.

In the first month, the NAV is Rs. 10. To withdraw Rs. 1,000, the fund needs to sell 100 units. After this withdrawal, 9,900 units remain. In the second month, the NAV increases to Rs. 12. Now, only about 83.33 units need to be sold to get Rs. 1,000, so the unit balance becomes 9,816.67. In the third month, the NAV goes up to Rs. 14, so only 71.43 units are sold, and the balance becomes 9,745.24 units.

This pattern continues every month. Although the number of units goes down with each withdrawal, the value of the remaining units may still grow if the NAV keeps increasing. For example, after three months, the investor has 9,745.24 units, and the NAV is Rs. 14. So the value of the investment is Rs. 136,433.36, which is higher than the original investment of Rs. 100,000, even after withdrawing Rs. 3,000.

However, if the NAV goes down instead of rising, the opposite happens. More units will have to be sold to get the same Rs. 1,000, and the total value of the investment may reduce over time.

Advantages of SWP

Flexibility: Under the SWP plan, investors have the versatility to opt for the amount, frequency and date as per their needs. Moreover, the investors can stop SWP at any point in time or can add more investments or even withdraw an amount extra and more than the fixed SWP withdrawals.

Regular Income: SWPs under mutual funds ease the investors by giving a regular income from their investment. Hence, it is highly suitable and highly useful for investors who want a regular income for meeting expenses.

Wealth gain: As mentioned in the above example, when the withdrawal rate of SWP is less than the return of funds, the investor also gets some capital appreciation in the long term.

No TDS: There is no TDS on the SWP amount for the resident individual investors.

Who Can Use SWP

Regular Secondary Income Seekers: SWPs are perfect for individuals seeking consistent supplementary income without liquidating their entire investment. By scheduling periodic withdrawals (monthly, quarterly, etc.), investors can create a reliable income stream that complements their primary earnings while allowing the remaining investment to potentially continue growing.

Capital Preservation-Focused Investors: Conservative investors prioritizing the protection of their principal amount can benefit from SWPs by carefully calibrating withdrawal rates to match or stay below the expected returns. This approach allows them to generate income while minimizing erosion of their investment base, particularly when using balanced or debt-oriented funds.

Self-Created Pension Planners: Those without formal pension arrangements can strategically use SWPs to build their own retirement income system. By accumulating a substantial corpus during working years and then setting up systematic withdrawals post-retirement, investors can create a dependable, pension-like income stream customized to their specific needs.

High-Tax-Bracket Individuals: SWPs offer significant tax advantages for those in elevated tax brackets. Unlike dividends (taxed at the individual’s income tax rate), SWP withdrawals are subject only to capital gains tax, often at lower rates. Additionally, only the gain portion of each withdrawal faces taxation, making SWPs considerably more tax-efficient for wealthy investors.

Tax Efficiency Through SWP

Systematic Withdrawal Plans (SWPs) can help reduce your tax burden compared to receiving dividends. With SWPs, you control when and how much money you withdraw from your investments, allowing for better tax planning. Since only the profit portion of your withdrawal is taxable, you’ll often pay less tax than you would on dividends, which are fully taxable.

Equity/Equity-oriented Funds: When using SWPs with equity funds (where at least 65% is invested in stocks), long-term capital gains (held for over 1 year) are taxed at 10% for gains exceeding Rs. 1 lakh per year. Short-term gains (less than 1 year) are taxed at 15%. This tax structure is typically more favorable than dividend taxation, especially for higher tax bracket investors.

Non-Equity Funds: For debt funds and other non-equity investments, SWP withdrawals held for over 3 years qualify for long-term capital gains tax with the benefit of indexation (adjusting for inflation), resulting in a lower effective tax rate of about 20%. Short-term gains (less than 3 years) are added to your income and taxed at your income tax slab rate.