Systematic Withdrawal Plan (SWP)

We have all grown up learning life lessons through stories. However, as we grow up and get entangled in the vicious cycle of life, we tend to forget those stories and their lessons (remember ‘moral of the story’). Today, through this article, I would like to take you back in time and remind you of this beautiful story that we have all heard in our respective childhood. The story of ‘A Hen That Lay Golden Eggs’. For those who don’t know or remember this story, it goes like this. There was a hen which laid one golden egg everyday. The owner soon became very rich and along with the wealth, came the greed to be richer and that too quickly. He soon became restless seeing only one golden egg being laid every day and thought of killing the hen to get all the eggs at once. He did that and, in the bargain, killed the hen that laid golden eggs. As a result of his greed, he stopped getting his daily supply of the golden egg. There are many morals of the story such as, be patient, don’t be greedy etc, etc.

Now let us see how our Mutual Fund investment corpus can become the ‘Hen’ which lays golden eggs (income through SWP) for its investors. The process is called Systematic Withdrawal Plan or SWP. The normal principle of financial planning is to reduce the equity exposure once a person retires and gets dependent on annuity (remember the thumb rule of 100-current age=equity exposure). In this rule it may get difficult to beat inflation. Instead, what an investor may do is, continue with her investments in equity mutual funds and based on certain parameters such as the corpus, monthly cash flow requirements etc, set up a SWP. Through this process the investor may kill 2 birds with 1 arrow. The first one being their monthly financial needs and the second one being coping up with inflation. There may also be a third benefit of adopting this process and that is probable wealth creation. Coping up with inflation means having surplus wealth after all the outflows/expenses.

SWP is a very flexible process and can be customised as per each investor’s requirement.

An investor has an option to select between twotypes of SWP i.e.

  • Fixed Amount SWP
  • Capital Appreciation SWP

1. Fixed Amount SWP: As the name suggests, an investor can set up a SWP for a fixed amount to be redeemed every month on a selected date. Here everything is pre-decided and cannot be changed until cancelled or the principal amount gets over. This option is best suited for retirees looking for monthly pension or investors having fixed commitments to honour such as EMI etc.

Capital Appreciation SWP: As the name suggests, under this option the scheme will release the pay-out only if it makes any profit. This option is preferred by investors who wish to book profits regularly instead of it getting re-invested.

In both the options, an investor has an option to set up SWP on a monthly/quarterly/half yearly or annual basis.

Paying tax on income/gains is a pain point for every investor. SWP efficiently tackles the impact of tax. By tax planning, one may be able to lower the tax burden and/or also differ the capital gains to subsequent years. Long term capital gains up to Rs.1 lakh is tax exempt. Let’s understand through an example.

Assuming an investor has Rs.1 crore accumulated in an equity fund (through SIP of Rs. 8000 pm for 20 years). She has a profit of Rs. 80 lakh If she chooses to redeem the entire amount, there will be heavy tax. However, if the investor chooses to withdraw an amount equivalent to his monthly expense through SWP, the taxable amount will be very low, resulting in lesser or NIL tax.

So the moral of the story is don’t cut (redeem/withdraw) the hen (all the investment corpus at once) that lays the golden egg (in form of income through regular SWP).

Views are personal: The author - Raghavv S Roongta is associated with Roongta Securities Pvt. Ltd and is a founder of YouTube channel ‘cluelessabtfinance’