Understanding Systematic Withdrawal Plans
Systematic Investment Plans (SIPs) have become a common terminology in most cities now. People use SIP as a generic name for mutual fund investments. We commonly hear people say they want to invest in SIP, like asking for Colgate when buying toothpaste or Bisleri for bottled water. Systematic withdrawal plan (SWP) is comparatively an unknown entity.
What is SWP?
In essence, SWP is the reverse of SIP. Where in SIP you look at accumulating a corpus by making regular investments into a fund, in SWP you regularly withdraw a fixed amount of money from a fund. The amount to be withdrawn and the frequency is fixed by the investor. So you can have a monthly, quarterly or annual frequency for any fixed amount that you wish to receive.
Mr Gupta would be very happy to receive a fixed amount in his account every month, when he retires. Anchal is currently on a sabbatical to bring up her baby. She would be thrilled to put her savings to use for generating a small regular income flow for herself. SWP can help Mr Gupta and Anchal plan their cashflows. This is one of the many methods available for generating a regular income from your savings.
Let us look at some examples of how this strategy will work. Say Mr.Gupta has Rs.10 lakhs which he wants to use for generating income through SWP. Let’s look scenarios with investments in three different type of funds.
Amount Invested: Rs 10 lakhs
Systematic withdrawal amount: Rs 10000 per month
Date of SWP: 2nd of every month
Start of SWP: 02 Feb 2010
End of SWP: 20 Feb 2013
Total amount withdrawn: Rs 240000
For simplicity we have taken three funds from the same fund house and not considered taxation in these calculations.
Balance in Folio as on 4 Feb 2013:
HDFC Top 200 Fund (G): Rs 9.07 lakhs
HDFC MIP LTP (G): Rs 8.71 lakhs
HDFC Income Fund (G): Rs 8.39 lakhs
(Source: Calculators mutualfundsindia.com)
Let’s look at a hypothetical case where you invest Rs 10 lakhs and the fund gives a return of 9%p.a. You run a SWP of Rs 10000 per month. In this case your funds will last you for 182 months. That means will be funding more than 15 years of your needs. In this case, if your annual withdrawal is less than the expected annual rate of return, then the SWP can run to perpetuity. So if our fund can be expected to give 9% return, if you draw only 7-8% of the invested corpus every year, you can use your one time investment forever.
Let us look some other popular fixed income products which are the Senior Citizen Savings Scheme (SCSS) and the Post Office Monthly Income Scheme (POMIS).
Both these schemes offer guaranteed returns. But they also have limitations in terms of amount,period and mode of holding. SCSS allows maximum investment of Rs 15 lakhs in one name and is currently offering a rate of 9.3% p.a. Which means you can get a minimum monthly income of Rs 7750 fromthis source. Similarly POMIS allows maximum investment of Rs 4.5lakhs in single name and Rs 9 lakhs in joint name. Current rate of return is 8.2%. Hence the maximum monthly income fromthis source can be Rs 6150. Both these incomes will be fully taxable as per the tax slab applicable to the investor.
So while the income is guaranteed and regular, there are other restrictions. In such scenarios, SWP option of MF becomes a strong contender for a place in the portfolio as a big support to these options.
Regularity: With an SWP, you are assured of getting a fixed amount at your pre-determined frequency. The problem with other options like a monthly income plans, which pay dividends, is that the amount and the frequency of the payouts is not fixed. Sometimes, if there is no appreciation which can be distributed, you might have no dividends to be paid. Hence every month you will have different amounts coming in and some month there might be no money received.
Taxation: SWP is better from the taxation point of view too. In debt funds dividends are paid after deduction of dividend distribution tax (DDT) of 13.5%. So that will be your tax in case you depend on dividend income from your debt mutual funds. In case of SWP, you will pay a short term capital gain (STCG) or a long term capital gains tax (LTCG). Though STCG may be more expensive as it is on the income slab of the investor, LTCG will be beneficial as it is a fixed rate of 10% or 20% with indexation. Things get better in case of SWP from equity funds. As the long term capital gains from equity mutual funds are exempt in case of holding beyond a year, you end up paying no tax on the withdrawals.
Inflation Protection: Most of the fixed income instruments do not offer inflation beating returns. So, thoughthe principal may be secure, the income might fall short of needs in future. Here again SWP scores in terms of generating returns to keep upwith inflation especially if you opt for an equity fund.
The only drawback in the SWP is that it will at some point eat into your capital. But judicious mix of investment instruments will ensure that your primary goal of income generation will be met without you running out of money in times of need.
So the conclusion is that SWP is a noteworthy strategy to use for generation of regular income in various scenarios.
The author is a member of The Financial Planners’ Guild, India (FPGI). FPGI is an association of Practicing Certified Financial Planners to create awareness about Financial Planning among the public, promote professional excellence and ensure high quality practice standards.