Meera moved from a full-time job to freelancing as her daughter was very young and she wanted to devote more time to her. Her freelancing assignment did not ensure a regular flow of income and that worried her a bit because she had the responsibility of her old parents on her.  She had made some savings but did not have a fair idea as to how could she use it judiciously to help her parents. She met a financial consultant who advised her to opt for Systematic Withdrawal Plan (SWP) which would ensure a regular cash flow as per her requirement.

Unaware of SWP, she enquired from the consultant what SWP was all about.

Meera: Could you please let me know what SWP is? Although I know what SIP is and have invested in it,I haven’t heard about SWP.

Consultant: While the investments you make via Systematic Investment Plan (SIP) allows you to invest in mutual funds in smaller amounts or amount of your choice periodically, under SWP you first invest your lump sum money in a mutual fund scheme and then initiate a withdrawal of fixed amount (based on your requirement) from that mutual fund at a time interval of your convenience which can be weekly, monthly, quarterly, half yearly or yearly. So, at a particular date that you choose, every month, units from your mutual funds are sold and the money is sent to your bank account. The benefit of SWP is that while your entire capital stays invested you enjoy the profits of appreciation.

Meera: Hmm, Ok.

Consultant (continues): An SWP could be a good choice in your kind of situation as it will bring regularity in your cash flow.

Meera: What are the important things I need to keep in mind regarding SWP?

Consultant: The type of fund you choose for starting SWP is very important. In your case, you may invest in a short-term debt fund & opt for a fixed amount to be withdrawn. A short-term debt fund is a mutual fund scheme that is meant for investments of about 1-3 years and aims to give stable returns.

There are two important things that you should keep in mind:

1. When you opt for a SWP, you should start by investing a large amount, of course, as per your capability. If you start with a big amount, there will be a significant positive momentum and it will put you on a stronger note.
2. Keep the amount to be withdrawn nominal because higher the withdrawal amount, faster will be the depletion of your capital money.

Meera: Ok that makes things clear. What about the tax implications of SWP from debt funds?

Consultant: The Systematic Withdrawal Plans (SWP) redemption works on the FIRST IN FIRST OUT (FIFO) method and the units bought first are assumed to have been redeemed first. Debt mutual funds, qualify for long term capital gains tax if investments are held on to for 3 or more years. The tax rate is 20%, with inflation indexation benefit on the original investment. If the investments are redeemed before 3 years, then short term gains tax is applicable which would be your current income tax slab rate.

In case you start SWP immediately, your debt fund capital gains would be taxable at your applicable income tax slab rate during the first 3 years of investment.

In case you start SWP from debt funds after holding them for 3 years, gains from debt funds would be clearly more tax efficient than other traditional investments, given the long-term capital gains tax treatment of debt funds.

Also, investors have this perception that in SWP the number of units held by them goes down over time. Whereas ideally one should focus on the value of their investment instead of how much units they own.

Meera: Sounds good. Thanks for letting me know about SWP. I think this is exactly what I wanted for my parents. Thanks a lot.

Mutual funds investments are subject to market risks, read all scheme related documents carefully.