Systematic Withdrawal Plans of mutual funds get a makeover: Here’s all you need to know

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Systematic Withdrawal plans (SWP) of mutual funds (MF) are going in for a makeover. Recently, Motilal Oswal Mutual Fund introduced the Motilal Oswal Fixed Amount Benefits (MFAB) Plan — a variant of the regular SWP. Earlier known as the Motilal Oswal CashFlow Plan, this helps investors get a regular cash flow from their existing investments in various schemes of Motilal Oswal Mutual Funds.

SWP: what’s changed?

Typically, when you enrol for an SWP, you mention a fixed amount that you wish to withdraw every month. Say, you need Rs 5,000 or Rs 1,00,000 every month. Now, instead of mentioning the amount, some fund houses allow you to mention the percentage of your investment that you’d like to withdraw. It’s a smart tweak that comes with a few benefits, the end result being the same. Units equivalent to the resulting Rupee amount are sold and you get the money in your bank account.

If you have been putting money in an MF via a systematic investment plan (SIP) or lumpsum, your fund house would compute the total market value of your investments in the fund as on the date of you apply for SWP. On that it would apply the percentage of your choice to ascertain how much money you would get every month.

MFAB allows investors to withdraw at the rate of 6 / 8 / 10 / 12 percent of the total corpus per year, monthly or quarterly. Thus, if an investor who has invested Rs 10 lakh opts for a monthly payout at the rate of 1 percent of the corpus (12 percent per annum), he will get Rs 10,000 per month.

SBI MF also offers SWPs that allow one to withdraw at regular intervals — monthly, quarterly, half-yearly or yearly — at the rate of 6 percent of the corpus per year. The fund house also offers the option of withdrawing a fixed sum at regular intervals.

ICICI Prudential Mutual Fund offers the Freedom SWP, which allows investors to withdraw at the rate of 6 percent of the corpus per year. It also allows investors to choose a top-up value of 3-5 percent.

For example, if an investor buys units of a scheme worth Rs 10 lakh, signs up for Freedom SWP at 6 percent per annum, and opts for a 4 percent top-up, then for the first year he will get Rs 5,000 per month. The following year his accruals will increase to Rs 5,200 per month (Rs 5,000 + 4 percent). This is designed to help meet one’s increased needs due to inflation, lifestyles changes, etc.

Percentage or fixed amount: which is better?

A fixed amount certainly looks better as you know exactly what you‘ll get. The percentage based option though appears a bit complicated, here’s why that SWP works better.

If you choose a larger fixed amount per month, then you are likely to exhaust your corpus sooner. In such cases, you might not realise how much is too much. For instance, if you think your monthly expense is Rs 20,000 and that’s the amount you fix to withdraw each month, a small corpus would get depleted pretty soon.

But when you opt for the percentage option, and got for a lower percentage, say, 6 percent, your money may last longer, especially if your investment in an equity fund (for example) is growing at a higher rate – say by 12 percent. In this example, your corpus itself would grow, resulting in income for longer period of time.

Can you change your SWP option midway?

Yes, you can. You can cancel an SWP, or change the amount, or duration. You cannot, however, convert a fixed sum SWP to a percentage-based one.

If you do not specify the last date (or month) of withdrawal, then the SWP is considered perpetual. It runs till all the units held are sold or you cancel it.

You can even add to your corpus by investing in more units in the same folio of the fund when an SWP is going on. An investor might like to top up his MF investments if he gets some money from other investments, like the maturity of a life insurance policy, fixed deposit, etc.

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An SWP can be initiated by filing up a form. The form needs details such as the date on which you want the money, the amount or percentage, frequency (monthly, quarterly, yearly), and your investment details (names of MF schemes, folio numbers, etc.). If you do not mention a date then the default date of the month will be chosen. There’s also a minimum payout threshold – say Rs 500.

Taxation

When it comes to taxation, investors are better off with SWPs than with dividend schemes if they are looking for regular income.

Ravindra Deshmukh, Certified Financial Planner and Founder of Arthmitra Financial Services, says, “An investor has no control on the quantum and the timing of dividend a scheme may declare. But with an SWP, an investor can clearly decide how much money he needs. While dividends are taxed in the hands of the investor, the money from an SWP is subject to capital gains tax.”

Thus, in the case of equity funds, it is better to start an SWP one year from the date of allotment of units. With debt funds, the wait period should be three years, if one wants to avail of the lower long-term capital gains tax rate, which is relatively attractive for those in the higher income tax brackets.

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“Individuals approaching retirement can park money in hybrid or balanced advantage funds and keep adding to their investments till they retire. An SWP started five to 10 years after the investment can ensure regular income in the golden years,” says Deshmukh.

Should you go for SWP?

Senior citizens or individuals keen on regular income may want to opt of SWPs. One should not confuse it with an annuity or pension income. Each time money hits your bank account, units are redeemed to that extent. Though there is enough marketing material containing back-tested data which indicates that your equity fund investments can last a couple of decades if you withdraw around 6 percent of your investment every year, there is no assurance that past trends will continue in future. In case of debt fund SWPs, the money is likely to be exhausted faster as the fund returns will drop with falling interest rates.

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Before enrolling for an SWP, figure out if you need regular income. For instance, you might already have a regular pension income, interest income from fixed deposits and bonds, yearly payouts from life insurance policies, and so on. A mutual fund SWP might not be required in that case. Don’t start an SWP just because it gives you the comfort of a ‘regular’ or ‘monthly’ income. Funds grow best if left untouched.

“It is always advisable to diversify your investment portfolio across different asset classes and investment options. If you already have investments in other regular income offerings, you may want to consider how SWPs can complement them in terms of diversification,” says Viral Bhatt, Founder, Money Mantra, a Mumbai-based financial planning firm. The suitability of SWPs for an individual investor depends on their unique financial circumstances, risk tolerance, investment goals, and time horizon, he adds.

There is the other side of the coin too. Harshad Chetanwala, Co-Founder, mywealthgrowth.com, is of the opinion that investors are better off redeeming mutual fund units as needed than signing up for an SWP. “Though an SWP offers a convenience to the investor by crediting a fixed sum to his bank account at regular intervals, many a time, not all the money is spent. Such unused funds do not earn much in a savings bank account,” he added.