This mutual fund facility gives you regular income. Here’s how

Efficiently using SWPs involves careful planning and consideration of various factors such as financial goals, risk tolerance, investment strategy, and tax implications.

If you invest regularly and accumulate a tidy corpus in the initial years leading up to your retirement, the SWP facility can be successfully triggered upon your retirement.

Investors can typically adjust the withdrawal amount or frequency according to their changing financial needs.

How to plan for a systematic withdrawal plan?

The investor initially invests a lump sum or start an SIP in mutual funds. Selecting funds that suit your investment objectives, risk tolerance, and time horizon is key.

Next, periodically rebalance your investment portfolio to maintain your desired asset allocation and risk profile. Rebalancing involves selling assets that have performed well and buying assets that may be undervalued, helping to manage risk and potentially improve long-term returns.

Maintain an adequate emergency fund separate from your investment portfolio to cover unexpected expenses or financial emergencies. Relying solely on SWPs for regular income without an emergency fund could expose you to liquidity risk if market downturns coincide with your withdrawal schedule.

Also read | Why systematic withdrawal plans in mutual funds work best for senior citizens

How much should I withdraw?

When you set up an SWP, fund houses give you a choice of how much you wish to withdraw. It could either be a percentage or an amount of money or number of units.

Remember, the rate of withdrawal that you choose should be lesser than the rate at which your fund grows. Otherwise, you would end up withdrawing from your capital, instead of gains. Experts advise that 4-6 percent per annum should be the annual withdrawal rate if you do not want to erode your capital amount.

The investor sets up a withdrawal schedule, specifying the frequency -- monthly, quarterly, etc - and the amount they wish to withdraw from their investment. Once the SWP is set up, withdrawals are automatically made from the investment account according to the specified schedule.

Investors need to determine a withdrawal rate that aligns with their financial needs and goals while considering factors such as expected investment returns, inflation, and the duration of withdrawals.

In the meantime, the remaining  investment continues to be managed by the mutual fund, generating returns or dividends.

What are the risks of a systematic withdrawal plan?

Note that SWPs expose investors to market risk, as the value of their investment may fluctuate over time, potentially affecting their income.

Further, the timing of market returns can significantly impact the success of SWPs. Poor investment performance early in retirement, coupled with regular withdrawals, can deplete the portfolio faster, making it challenging to recover, even if returns improve later.

SWPs may be susceptible to behavioural biases such as panic selling during market downturns or increasing withdrawals in response to short-term financial needs.

Mutual funds may charge fees for setting up and managing SWPs, which can eat into the investor's returns.

How to do tax planning for SWPs?

SWP redemptions in mutual funds follow the first-in-first-out (FIFO) principle, whereby units purchased first are considered to be redeemed first.

For equity investments, long-term capital gains tax of 10 percent is applicable on gains exceeding Rs 1 lakh if held for over a year. Short-term capital gains tax of 15 percent applies if held for less than one year.

For non-equity investments, including debt funds, taxation is based on the investor's slab rate for investments made on or after April 1, 2023.

SWPs can be a useful tool for generating regular income from investments, but investors should carefully consider their individual financial goals, risk tolerance, and investment strategy before implementing an SWP. Consulting with a financial advisor can help determine whether an SWP is appropriate for a particular situation.