When it comes to receiving regular income from investments, there are a handful of options for an individual investor like interest from bank deposits, SWP (Systematic Withdrawal Plan) of mutual funds, etc. When it comes to tax efficiency, SWP reigns supreme. SWP for Regular Income is a great arrangement for retirees who want to invest in mutual funds for capital appreciation.
How SWP work?
- It is a mode of regular fixed payout as per investor’s mandate for cash flow requirement.
- Units from the outstanding pool (One scheme) is redeemed to the extent of fixed amount as opted by the investor on a specific period.
- Credited/paid to the investor’s bank at a chosen frequency (Weekly, Monthly, Quarterly etc).
- The mandate continues to operate till all the outstanding units are redeemed/exhausted.
- Withdrawal amount can be utilized for various requirements including investment in other option.
We have written on STP sometime ago in Details. Please click here to access that article.
How SWP for Regular Income is Tax Efficient?
Before we get into the details, it is pertinent to layout certain facts.
Interest from bank deposits is taxed in the hands of investors as per the applicable income tax slab.
Dividend income from direct equity / mutual funds. The detail we need to stress upon here is that the entire cash flow received by the investor is subject to tax.
The beauty with the ‘Simple’ SWP is that only the gain component of the cash flow is subject to tax. This is a major difference that substantially reduces the tax impact.
Let us check with this example.
Initial investment in growth plan of mutual fund scheme – Rs. 1,20,000
Monthly cash flow (Withdrawal) – Rs. 800 per month
The working is as follows:
In the above example, since bulk of the money withdrawn is accounted for by the principal component, the cash flows are more tax-efficient. Isn’t this a smart choice?
SWP is also better than dividends – Simply for the reason that Dividends are Taxable in the hands of the investor. Also, dividends cannot be guaranteed in terms of the amount of payment & frequency. (Details)
How to use SWP effectively?
All investors can benefit from SWP in Mutual Funds. Here are some examples in which you can include them effectively in your financial planning-
- Retirement Planning
SWP is a great strategy to fund financial needs post-retirement. This facility is especially handy for retirees who do not have a pension or other such regular source of income. It is seen that an SWP of around 6/8% annually can be used to make annuities with your capital protected.
- Supplement salary income
Salaried individuals can use SWP as a second source of a second income. It can help them fund specific financial goals such as children’s education, purchase of consumer goods, paying off loans, etc.
- Freelancers/Irregular Income Earners
The biggest challenge faced by freelancers or self-employed professionals is lack of a steady or fixed income. There may be months where they would be minting money but there could be some dry spells as well. In such cases SWPs help to bring stability to one’s financial life.
- Nearing your financial goals
Many investors use SWP in an extremely smart manner, especially when the markets are doing well. They invest in an equity mutual fund as they have the potential to generate higher returns. Once they reach their desired corpus, they can opt for an SWP. Through this facility, they move the funds from the equity investments to a relatively safer/ non-volatile option such as Bank Deposits, etc.
Setting up SWP
Setting up a Systematic Withdrawal Plan is a simple process.
All you need to do is fill up the SWP Form (with the details like the amount to be withdrawn, periodicity etc.) and submit to the fund house or your distributor.
Also SWP is available online with most MFs and transaction platforms like BSE, NSE & MFU.
