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What is SWP (Systematic Withdrawal Plan)?
When it comes to liquidating mutual funds, most investors tend to either redeem all the units or simply just a part of their holdings. However, there’s another redemption method that many investors are not aware of - SWP or Systematic Withdrawal Plan. Wondering what the meaning of the Systematic Withdrawal Plan is? Here’s a comprehensive guide explaining the concept, how it works and the various advantages it offers.
What Is SWP in a Mutual Fund?
Systematic Withdrawal Plan (SWP) is a unique mutual fund redemption method that allows you to withdraw a fixed predetermined amount at specified intervals. Think of it as a Systematic Investment Plan (SIP) but for mutual fund redemption. Investors often use SWP as a way to receive regular income from their mutual fund investments without redeeming them entirely.
How Does a SWP Work?
Now that you’re aware of what SWP in a mutual fund means, let’s try to understand how it works with the help of a hypothetical example.
Assume you invested a lump sum amount of Rs. 5 lakhs in an equity-oriented mutual fund 5 years ago. Currently, the value of your investment is Rs. 7 lakhs. Since you wish to create a steady income stream from your mutual fund investment, you decide to set up a Systematic Withdrawal Plan where you withdraw Rs. 20,000 each month until you completely redeem all of your mutual fund units.
On the first day of each month, the SWP determines the number of units that need to be redeemed to fulfill your withdrawal request. The number of units to be redeemed is determined by dividing Rs. 20,000 by the Net Asset Value (NAV) of the mutual fund on the first day of each month.
Now, if the NAV of the fund is Rs. 200 on the first day of a month. The SWP will redeem 100 units (Rs. 20,000 ÷ Rs. 200). And if the NAV of the fund rises to Rs. 205 in the subsequent month, the Systematic Withdrawal Plan will redeem 98 units. This process is repeated each month until there are sufficient mutual fund units to redeem.
Who Should Consider SWPs?
Systematic Withdrawal Plans can be particularly advantageous for the following category of investors.
- Investors looking to create a steady stream of income to cover their living expenses.
- Investors who wish to distribute their mutual fund investments to their beneficiaries in a systematic manner.
- Investors who wish to save tax can use SWP to reduce their overall liability.
- Investors with specific financial goals like funding a home purchase or their child’s education expenses.
Advantages of Systematic Withdrawal Plans
As an investor, you not only need to know the meaning of SWP in mutual funds but also be aware of its various benefits. Here’s a quick overview of some crucial benefits Systematic Withdrawal Plans offer.
Regular Income StreamBy setting up a SWP, you can effectively create a consistent, predictable and regular income stream for yourself irrespective of how the market moves. If you’re fast approaching retirement or are simply looking to supplement your main source of income, opting for a Systematic Withdrawal Plan can be hugely beneficial.
FlexibilityAnother major benefit of SWP is that it is completely flexible and customizable. You get the freedom to choose the redemption amount and the frequency according to your requirements. Most mutual funds offer monthly, quarterly, semi-annual and annual withdrawal frequencies.
Tax SavingsThe gains from your mutual fund investments are subject to either long-term or short-term capital gains tax depending on how long you hold them for. In the case of long-term mutual fund investments, only gains above Rs. 1 lakh are taxed at 10%.
By setting up a Systematic Withdrawal Plan, you can ensure that the total amount of gains you get during a year is below the taxable threshold limit of Rs. 1 lakh. This will allow you to bypass long-term capital gains tax entirely. You don’t get such a benefit if you redeem all your mutual fund units at once.
Elimination of Market-TimingTiming the market can be very tough and risky due to the unpredictable nature of the stock market. Since Systematic Withdrawal Plans automatically redeem your mutual fund units at predetermined intervals, the need to time your market exit doesn’t arise.
With this, you must now be aware of the meaning of SWP in mutual funds. As you can see, it is a very useful redemption method that can provide you with a stable and predictable source of income. With a Systematic Withdrawal Plan, you can effectively manage your cash flows and reduce your overall tax liability significantly.