Smart Money. How Systematic Withdrawal Plans work

I recently met up with a friend who was planning to retire in a couple of years. As we chatted over his plans on how to occupy his time post retirement, he disclosed his primary worry.

It centred on how to create a steady income stream from his investments without having to liquidate all of it at one go and lose out on potential market rallies. Mistiming the markets can happen with withdrawals too!

Mr. Sen is not alone. Like retired professionals, there are families who, after losing their bread-earner, need a regular income stream to meet the family’s household expenses.

Then there are professionals such as artists or musicians, who are looking to stabilise their erratic cash flow patterns.

Is there a mutual fund that can providea tax free regular income? Enter Systematic Withdrawal Plans (SWP).

You may know the systematic investment plan (SIP) well, where you instruct a fund house (asset management company or AMC) to make investments of a fixed sum at regular intervals, usually every month.

An SWP is simply the reverse of SIP. You instruct the AMC to redeem units at a fixed date and credit a fixed sum into your bank account.

A simple example will help give you a better understanding. Say Mr Sen has monthly expenses of ₹40,000 and his equity fund portfolio totals ₹30 lakh, and he’s held these funds for more than a year.

With an expected long term rate of return at a reasonable 10 per cent per annum, if Mr. Sen activates an SWP of ₹40,000, he can expect tax free monthly income for the next 9.5 years.

If the portfolio delivers a return of 12 pc per annum, it will last for 10.91 years.

SWP scores over relying on mutual fund dividends for regular income, as it brings stability of income; the quantum of dividend is not guaranteed & it largely depends on market movements and the profits that the AMC earns.

But note a few important points. The first is that you cannot run an SIP and SWP in the same fund.

Second, inflation is likely to increase the monthly withdrawal amount each year to meet expenses.

The third is that there will be fluctuations in the inflation rate as well as the portfolio return which can considerably impact the portfolio.

The fourth is taxation. Since an SWP is nothing but redemption of units from the scheme, the tax treatment of each withdrawal will be the same as in the case of full withdrawal of equity and debt funds.

Hence, for units where the period of holding has not crossed 12 months for equity funds, there might be a short term capital gains tax.

For debt funds, there will be a tax liability (short-term capital gains on holding for less than 36 months and long-term capital gains on longer holding periods)which need to be factored in. You also need to be mindful of the exit load of the scheme before activating the SWP on that folio.

Finally, note that starting an SWP does not mean that you stop monitoring the scheme performance.

In case the same is not up to the mark, don’t delay shifting your funds to another scheme.

To activate an SWP, you need to simply fill out an instruction slip with the AMC stating the folio number, the withdrawal frequency, date for the first withdrawal and the bank account to credit the proceeds.

You can select a withdrawal frequency you like — monthly, quarterly or half yearly.

The writer is a SEBI Registered Investment Adviser, is a member of The Financial Planner’s Guild, India www.fpgindia.org

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