Systematic withdrawal of investments is becoming quite common. Now, a SWP (Systematic Withdrawal Plan) can be executed in equity, debt and hybrid mutual fund plans. Touted as an efficient way to cash out for pensioners and pensioners, the SWP can be used to conduct relatively tax-efficient transactions, depending on your needs. Here is a complete overview of SWP in terms of operation, taxation and structure.
How SWP is performed
Taking the SWP route in a mutual fund allows you to withdraw fixed or variable amounts at regular intervals – monthly, quarterly or annually. Take the example of Manav. He must make a lump sum investment in a mutual fund and then set a date for periodic withdrawals. Suppose Manav invested a lump sum of ₹5 lakh in an equity mutual fund on January 5, 2022, whose net asset value was ₹100 on that day. This means that the investment was made in 5,000 units of this mutual fund. Manav chooses to withdraw ₹10,000 each month from February 1, 2022, when the net asset value was ₹102. The investment value on the day was ₹5.1 lakh, which decreased to ₹5 lakh, after the withdrawal as well as the unit reduction (4,902), as 98 units were redeemed. Therefore, the same process continues each month until the end of the SWP.
Taxation of withdrawals
In an equity-oriented mutual fund, if a redemption occurs before one year of investment, a short-term capital gains tax of 15% will be levied on the realized capital gains. If held for more than a year, a 10% long-term capital gains tax is applicable over 1 lakh of profit. Capital gains on redemptions of non-equity oriented mutual funds will be taxed at your income tax rate, if redemptions are made before 36 months of investment. If the holding period is longer than 36 months, a 20% long-term capital gains tax with indexation benefit is available. You can optimize your tax outflows if you plan your withdrawals intelligently.
Generally, there are two options under SWP. First, you can opt to withdraw a fixed amount at periodic intervals according to your preference. Second, you can choose to receive only the capital appreciation portion for specified intervals and therefore no amount will be withdrawn from the principal. Additionally, one can receive variable periodic withdrawals based on market valuation multiples, sentiment parameters, and volatility metrics via Kotak’s Smart SWP. However, note that variable withdrawals actually defeat the purpose of averaging rupee costs that systematic plans aim to achieve.
How to structure your SWP
The SWP is generally used by retired people while it can even be used for some specific purposes. Structure your SWP with tax implications and goals in mind. If you want to have an equity SWP or an equity-focused hybrid fund for post-retirement purposes, you can invest a small portion of your capital one year before retirement. With debt funds, you can invest about three years before retirement, to make regular withdrawals that are tax efficient. The dual objective of fighting inflation and taxation is important to maintaining your kitty throughout your life. As a general rule, the withdrawal rate should not exceed 4% per year if you retire at age 60.