Systematic Withdrawal Plan: A Smart Way To Manage Investments

Exiting the market intelligently is just as crucial as entering it. We generally plan our entry through SIPs properly but forget to plan when and how to exit. To ensure a seamless exit, having a well-thought-out plan is essential, and for this, a systematic withdrawal plan (SWP) can be a fruitful solution, not only for retirees but also for young investors with a good corpus. Rakesh Deshmukh takes a closer look at how SWP can work in your favour [EasyDNNnews:PaidContentStart]

SIP, or systematic investment plan, is something most of us are familiar with and often use to meet our financial goals or future needs. It allows us to invest small amounts—starting from as low as ₹250 or ₹500—on a daily, weekly, monthly or quarterly basis. Another way to invest in mutual funds is through a lump sum investment, where you invest a larger amount, like ₹1 lakh, all at once. Unlike SIPs, which automate regular savings, lump sum investments require you to make a fresh transaction each time. With SIPs, you just need to set up a one-time standing instruction. 

Now, you may be wondering why I am explaining SIPs and lump sum investments. Don’t worry: it will all make sense as we go further. Exiting the market intelligently is just as crucial as entering it. To ensure a seamless exit, having a well-thought-out plan is essential. Now, imagine you have reached your retirement age. At this stage, you are either relying on your children or on the savings and the investments you have built over the years. The challenge here is adjusting to life without the monthly salary you were used to during your working years. Since you no longer have that pay cheque coming in, you have two options. 

First, many people choose to redeem all their investments at once after retiring, putting the lump sum into a savings account and withdrawing as needed. Some intelligent individuals park some of the money in fixed deposits. However, this can lead to inconsistent withdrawals – sometimes too much, sometimes too little – posing the risk of depleting your funds faster than expected. Another issue with redeeming your entire investment is inflation risk and also the issue of taxation. Parking the lump sum in a savings account won’t keep up with inflation, thus reducing your money’s value over time. 

Even blocking it in fixed deposits (FDs) won’t help much as they barely generate returns that beat inflation, leaving you with lesser financial security. On the other hand, more financially savvy individuals choose to withdraw systematically. They set up a one-time standing instruction with AMCs or fund houses to credit a fixed amount to their savings account each month from their mutual fund investments. This way, they ensure a steady income flow without the worry of overspending or running out of money too soon. 

Here’s where the SWP (systematic withdrawal plan) comes into the picture. Instead of withdrawing funds randomly or in lump sums, an SWP allows you to withdraw a fixed amount from your mutual fund investment at regular intervals— monthly, quarterly or yearly. This ensures that, much like the salary you were accustomed to during your working years, you continue to receive a steady stream of income even after retirement or when you are no longer actively working. Such a constant flow of income per month or as per your defined period ensures that your income and expenditure plan is not disrupted. 

It allows investors to withdraw a fixed amount from a mutual fund regularly or some funds houses allow a percentage of your total corpus, as for example, 5 per cent of your total corpus every year. If your total corpus is ₹1 crore, ₹5 lakhs will be taken out every year. Moreover, you have the flexibility to decide both the withdrawal amount and the frequency. You can also opt to withdraw only the gains, preserving your invested capital. On the chosen date, units from your mutual fund are sold, and the proceeds are transferred to your account. 

How SWP Works
SWP generates cash flows by redeeming a certain number of units from the scheme at a set interval. The number of units redeemed to create this cash flow is based on the SWP amount and the scheme’s NAV on the withdrawal date. Here is an example: an investor makes a lump sum investment of ₹10 lakhs in a mutual fund scheme. The purchase NAV is ₹20, which results in 50,000 units being allotted. Now, assume the investor initiates a monthly SWP of ₹6,000 after a year to avoid exit load charges. 

In the first month, if the NAV is ₹22, to generate ₹6,000, the AMC redeems 272.728 units (₹6,000 divided by ₹22). This reduces the unit balance to 49,727.272 (50,000 – 272.728). In the second month, assuming the NAV is ₹22.50, the AMC redeems 266.667 units (₹6,000 divided by ₹22.50), reducing the balance to 49,460.605 units. In the third month, with an NAV of ₹23, the AMC redeems 260.870 units (₹6,000 divided by ₹23), further reducing the unit balance to 49,199.735. 

This process repeats monthly, reducing the unit balance as withdrawals happens. If the scheme’s NAV appreciates faster than the rate of withdrawal, the investment value can still grow. Continuing with the example, after three SWP payments, the investment value stands at ₹11,31,593.91 (49,199.735 units x ₹23 NAV), reflecting a gain of ₹1,31,593.91 over the initial investment of ₹10 lakhs. However, if the NAV decreases, more units would need to be redeemed to generate the same cash flow, which would reduce the investment value. 

Benefits of SWP
The SWP offers several benefits for investors seeking regular cash flow from their investments in mutual funds. Here are the key advantages: 

■ Regular Income Stream - SWP allows investors to withdraw a fixed amount at regular intervals (monthly, quarterly or yearly), making it an ideal solution for those seeking a steady income flow. This is particularly useful for retirees or individuals looking for periodic cash flow without liquidating their entire investment.
■ Flexibility - Investors have the flexibility to choose the withdrawal amount and frequency that suits their needs. They can adjust the amount or stop the withdrawals whenever required. This customisation helps meet specific financial goals or needs. As we know, inflation is increasing every year, which means the value of your money is decreasing, and hence your purchasing power is falling. To cope with this situation, you need to withdraw more every year. For example, if you are withdrawing ₹3 lakhs a year, considering inflation at 5 per cent, you would need to withdraw ₹3.15 lakhs the next year to cover the same expenses. This can be done easily with SWP, as it offers the flexibility to choose the amount and frequency according to your needs.
■ Tax Efficiency- SWP is more tax-efficient compared to traditional income sources like FDs. In SWP, only the capital gains portion (the difference between the NAV at the time of investment and the NAV at the time of redemption) is taxed, while in FDs, the entire interest earned is taxed as income.
■ Capital Appreciation Potential - Even as you withdraw regularly through SWP, your remaining investment continues to benefit from potential capital appreciation. If the fund performs well, the NAV may rise, potentially increasing the overall value of the remaining investment.
■ Avoiding Market Timing - SWP eliminates the need to time the market. Since you are redeeming units periodically, you benefit from averaging out your withdrawals, minimising the impact of short-term market volatility on your withdrawals.
■ Better Alternative to dividends - SWP offers a more predictable and steady cash flow compared to dividend plans in mutual funds, which depend on the fund’s performance and declaration by the fund house. With SWP, you know exactly how much you will receive at each interval.
■ Preserving Capital - By withdrawing a fixed amount and leaving the remaining investment intact, SWP allows you to preserve a portion of your capital for future needs. If the NAV appreciates over time, your investment may even grow despite the withdrawals. You can also opt to withdraw only the gains, preserving your invested capital.
■ Customisation for Financial Goals - SWP can be tailored for different financial goals, such as meeting regular expenses, supplementing retirement income, or funding a child’s education. It offers a way to systematically draw down on your investments while still maintaining growth potential. 

Investment in Fixed Deposit versus SWP on Retirement
Let’s say you retire at 60 with a corpus of ₹1 crore and invest it in a FD at an interest rate of 7 per cent. Your yearly expenses are ₹5 lakhs. However, you must also account for inflation. Assuming an annual inflation rate of 5 per cent, in the first year, your interest income would be ₹ 7 lakhs, and your inflation-adjusted withdrawal would be ₹5.25 lakhs. This would leave you with a corpus of ₹1.0175 crore at the end of the first year. 

By the time you reach age 68, your inflation-adjusted withdrawals will start to exceed the interest earned on your remaining corpus. At 84, you would still be able to make a full withdrawal to cover your expenses, but by age 85, you would face a shortfall of ₹10.33 lakhs. If the interest rates drop, this shortfall could occur as early as age 80, leaving you unable to cover your retirement expenses. 

Now, let’s examine the SWP with an 8 per cent and 9 per cent return on your investment of ₹1 crore while keeping the same withdrawal amount and inflation rate as mentioned earlier. With an 8 per cent CAGR return, you will begin receiving less interest than your withdrawals by age 74, compared to 70 years for fixed deposits. At age 88, you can still withdraw the necessary amount, but by age 89, your funds will be insufficient to cover your annual expenses. 

With a 9 per cent CAGR, by age 83, your inflation-adjusted withdrawals will surpass your annual gains, compared to 70 years with FD and 74 years at an 8 per cent CAGR. At age 97, you can still withdraw your yearly needs, but beyond that, it won’t be sufficient. 

SWP Beyond Retirement
If you think SWP is only for retirement, that’s not true! You can use it in many situations. For example, you can use it if you are a working professional wanting to advance your career with an Executive MBA from a top university like IIM. It costs around ₹35 lakhs and the institute allows payment in instalments. Setting up an SWP can help cover your fees, with withdrawals matching your EMI schedule whether quarterly, semi-annually, or as needed. 

This way, your investment can keep growing while you manage your education expenses. Similarly, if you have debts like home or automobile loans, an SWP can help manage them too. Regular withdrawals from your investments can create a steady cash flow for monthly payments. This allows you to avoid selling your investments all at once, letting them grow while you steadily pay off your debts. 

Tax Considerations
The tax on SWPs varies based on the type of mutual fund equity or debt. For equity funds, if the units are held for more than a year, long-term capital gains (LTCG) exceeding ₹1.25 lakhs are taxed at 12.5 per cent, making them a favourable option for long-term investments. However, if the equity units are redeemed within a year, the short-term capital gains (STCG) are taxed at 20 per cent. This makes equity funds more tax-efficient for longer holding periods compared to Debt Funds. 

If you had bought 1,000 units in any equity fund in January 2024 at a NAV of ₹100 each and withdrew ₹5,000 the next month when the NAV was ₹102, you will redeem 49.02 (₹5,000 divided by ₹102) units. You will only pay tax on the gain of ₹98 (49.02 * ₹102 – ₹100), and it will be considered as short-term gains, taxed at a 20 per cent rate, considering the fund is equity-oriented. 

The tax amount will be ₹19.60, which would be zero if the amount had remained invested for more than a year and was sold afterwards due to the tax exemption of up to ₹1.25 lakhs. In contrast, with a fixed deposit, the entire interest earned is taxed. So, if you earned ₹5,000 as interest from an FD, you would have to pay ₹1,560 in tax if you fall under the 30 per cent tax bracket, including a 4 per cent cess. 

Timing the SWP
Setting up a SWP for post-retirement income is straightforward. However, when you are using an SWP to gradually exit while approaching a financial goal, timing is crucial. It’s generally advised not to initiate the SWP immediately after making your initial investment. Allow the investment to grow for a few years before starting withdrawals. This ensures your original capital has time to generate returns so that you are not withdrawing from the principal too soon. For example, if you start withdrawing right after investing and the market drops, your SWP could quickly eat into your capital, leaving less room for recovery. 

Additionally, waiting to set up an SWP can be more taxefficient. As we have learned above, if you hold equity investments for more than 12 months, capital gains up to ₹1.25 lakhs per financial year are tax-free, and any gains beyond that are taxed at a lower rate compared to short-term capital gains. Experts suggest reviewing your portfolio a few years before your goal, especially for non-negotiable goals like children’s education or home purchases. Data suggests that there’s a one-in-three chance your portfolio could lose value within a year, but the risk decreases significantly over a three-year period. 

If you are close to your target, consider shifting funds to safer options like liquid funds and start an SWP. However, if you are still short, starting an SWP can help secure part of the corpus while letting the rest grow. When planning your exit through an SWP, you are effectively reducing the risk to your target amount. This ensures that you don’t sell at the lowest point in the market, but also means you won’t sell at the highest point either. An SWP balances out extreme market fluctuations, which is a solid strategy for most investors. The goal of an SWP is to minimise losses while still leaving room to benefit from potential gains.

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