Systematic Withdrawal Plan (SWP): Meaning and How It Works

Investing is about more than just systematically entering the market. Having an exit plan is also essential so you can redeem investments methodologically. In the previous chapter, you learnt about redemptions; in this chapter, you will learn about the systematic withdrawal plan (SWP).

What Is SWP?

Compared to a 'dividend' plan of a mutual fund, a SWP is more suitable for retirees, who are typically looking for a fixed flow of income. Though dividends act as a decent income source, they could be more efficient since dividends are not guaranteed, and the amount and frequency are at the discretion of the fund house. One also may or may not receive dividends every month.

On the other hand, a SWP allows investors to choose the amount they wish to withdraw and the frequency at which they want to do so. You instruct the fund house to redeem a fixed amount on a particular day every month and credit the proceeds to your bank account. Once instructed, it works on autopilot.

SWP vs SIP

SWPs work exactly the opposite of SIPs. Like in an SIP, a particular amount is deducted from your bank and invested monthly. In SWPs, you already have an investment with the fund house, so instruct them to redeem a part of it and credit it to your bank account every month. This is a more reliable way if you need this money for your living expenses.

For example, if you have ₹1 crore invested in a mutual fund, you need ₹50,000 monthly for your living expenses. You can instruct the fund house to redeem units worth ₹50,000 on the 5th of every month. This instruction automatically redeems the units and transfers the money to your bank account.

How Does SWP Work?

Building a sizable corpus is a battle half won; the other half is preserving it. This is why you must formulate a strategy to ensure your story doesn't become part of the riches-to-rags list. To avoid the descent from affluence to financial stress, you need to know two crucial elements: where to stash your money and how much you can annually withdraw to finance your daily life.

So, without further ado, let's look at the different funds you can invest and establish an annual withdrawal rate to ring-fence your hard-earned wealth. Note that this analysis is based on historical data to help you take cues and form expectations only.

Equity Mutual Funds

These funds invest more than 80% of the amount in equity. Assuming you put ₹50 lakh corpus in an equity mutual fund 10 years back. You put in the principal and start withdrawing a fixed sum every month. You might be thinking, that the funds may get exhausted soon. However, this is what it looks like if you continue to withdraw for 10 whole years: 

*Note - The following example assumes 13% CAGR growth.

• Case I: If you withdraw 4%, i.e., ₹2,00,000 out of your corpus every year (₹16,667 per month) for 10 years, you'd have ₹1.30 crore at the end of the tenure.
• Case II: If you withdraw 5% i.e., ₹2,50,000 out of your corpus every year (₹20,834 per month) of your corpus every year for 10 years, you'd have ₹1.21 crore at the end of the tenure.
• Case III: If you withdraw 6% i.e., ₹3,00,000 out of your corpus every year(₹25,000 per month) of your corpus every year for 10 years, you'd now have ₹1.11 crore at the end of the tenure.

Annual Withdrawal %	Monthly Withdrawal Amount	Corpus at the end of 10 years
4% of the initial corpus	₹16,667	₹1.30 crore
5% of the initial corpus	₹20,834	₹1.21 crore
6% of the initial corpus	₹25,000	₹1.11 crore

The main advantage of doing an SWP in an Equity Mutual Fund is that with the growth potential of equity, you can have an even larger corpus than you originally invested. 

However, putting all your money in an equity fund can be a rollercoaster ride. For example, during these 10 years, your corpus would have swung between ₹45.46 lakh and ₹1.14 crore if your annual withdrawal rate was 6%. The value of your corpus would have come close to the starting principal amount (of ₹50 lakh) in the last 10 years if your annual withdrawal was 6% at least 3 times.

Even though this option can accelerate your investment, there is a risk of a diminished corpus because equity can have massive fluctuations over short periods. Given the volatility, putting a sizable amount of money in an equity fund can be tricky. So, consider investing in a flexi-cap fund only if you don't depend on it for regular income and have another income source.

Aggressive Hybrid Fund

These funds invest 65-80% of the amount in equity and the rest 20-35% of the amount in debt.

Assuming you put ₹50 lakh corpus in an aggressive hybrid fund 10 years back. You put in the principal and start withdrawing a fixed sum every month. You might be thinking, that the funds may get exhausted soon. However, this is what it looks like if you continue to withdraw for 10 whole years: 

*Note - This example assumes 12% CAGR growth 

Annual Withdrawal %	Monthly Withdrawal Amount	Corpus at the end of 10 years
4% of the initial corpus	₹16,667	₹1.18 crore
5% of the initial corpus	₹20,834	₹1.09 crore
6% of the initial corpus	₹25,000	₹0.99 crore

The advantage of investing in an Aggressive Hybrid Fund is similar to an equity fund as it also provides growth potential. But, considering the volatility of equity as an asset class, the corpus would have dipped to ₹47.08 lakh at some point in the last 10 years. The value of your corpus would have come close to the starting principal amount (of ₹50 lakh) in the last 10 years if your annual withdrawal was 6% just 1 time.

Although volatile, it is relatively more stable than a 100% equity fund (like a flexi-cap fund). This option suits investors with low dependency on the corpus for regular income.

Conservative Hybrid Fund

These funds invest just 10-25% of the amount in equity and the remaining 75-90% of the amount in debt.

Assuming you put ₹50 lakh corpus in a conservative hybrid fund 10 years back. You put in the principal and start withdrawing a fixed sum every month. You might be thinking, that the funds may get exhausted soon. However, this is what it looks like if you continue to withdraw for 10 whole years: 

*Note - This example assumes 8% CAGR growth 

Annual Withdrawal %	Monthly Withdrawal Amount	Corpus at the end of 10 years
4% of the initial corpus	₹16,667	₹78 lakh
5% of the initial corpus	₹20,834	₹70 lakh
6% of the initial corpus	₹25,000	₹62 lakh

Investing in a conservative hybrid fund is much safer and less risky compared to the previous two options. Although, you risk having a lower corpus than the other options mentioned above.

Here, corpus value would have eroded 7 times in the last 10 years if your annual withdrawal was 6%. That's mainly because this fund category is primarily affected by market volatility and, as a result, grows your corpus slower. It is ideal for risk-averse investors relying on the corpus for regular income.

Debt Fund

These funds invest more than 100% of the amount in debt. 

Assume you put ₹50 lakh corpus in a debt fund 10 years back. You put in the principal and start withdrawing a fixed sum every month. You might be thinking, that the funds may get exhausted soon. However, this is what it looks like if you continue to withdraw for 10 whole years: 

*Note - This example assumes 6% CAGR growth 

Annual Withdrawal %	Monthly Withdrawal Amount	Corpus at the end of 10 years
4% of the initial corpus	₹16,667	₹62 lakh
5% of the initial corpus	₹20,834	₹55 lakh
6% of the initial corpus	₹25,000	₹49 lakh

It is the least risky and volatile instrument to do SWP in. As this is a low-risk, low-reward option, your corpus will grow slowly. If you withdraw slightly higher amounts (check the 6% withdrawal number), you can eat into your ₹50 lakh corpus.

The value of your corpus would have come close to the starting principal amount (of ₹50 lakh) in the last 10 years if your annual withdrawal was 6% about 10 times, this is simply because the growth is limited due to lower returns. Although safe, there are better choices than putting all your money in debt, as it can lead to capital erosion in the long run.

Key Takeaways

• Annual 6% withdrawal could have diminished corpus in the last 10 years. So, it's best to look at lower withdrawal rates.
• The 6% annual withdrawal rate can be harsh, particularly for those with ₹50 lakh corpus in a short-duration debt fund. Even conservative hybrids come too close to shaving off your corpus in 10 years.
• Pure equity funds - like flexi-cap funds - can enlarge your corpus significantly but at a relatively higher risk. The 100% equity option can be precarious for retirees.
• Aggressive hybrid funds appear to be the best fit. They can grow your corpus and often protect your original investment.

Finally, for those who are interested in our methodology, here is how we assessed the four types of funds to answer your questions:

• The ₹50 lakh corpus was put in direct plans of these funds in January 2013.
• The annual 4%, 5% and 6% withdrawals were done on January 15 of each year.
• We calculated the pre-tax corpus and assumed a 5% incremental withdrawal each year to cope with inflation.
• We selected the funds based on the average ranking in the last 10 years.
• Equity savings funds were excluded as they had only one fund in the 10-year ranking.

Tax Implications in the Case of SWP

The taxation rules remain the same and depend on whether the fund is an equity or non-equity fund. Mutual Funds that invest at least 65% in domestic equities are considered equity funds; the others are called non-equity funds. Here is how they are taxed:

• Equity-oriented Funds: Gains on investments withdrawn under 12 months are all treated as short-term capital gains and taxed at 15%. Investment gains realised after 12 months are considered as long-term capital gains and taxed at 10%. Long-term capital gains on mutual funds up to ₹1 lakh are exempt from taxation every financial year.
• Non-equity-oriented Funds: Gains on investments held for more than three years are considered as long-term capital gains and taxed at 20% after providing the benefit of indexation. If sold within three years, the gains are added to the taxable income and taxed per the applicable slab.

If the investment was made over a period, such as in the case of SIPs, the first-in-first-out (FIFO) method is considered. The units bought first are assumed to be redeemed first. However, debt funds and equity funds have different tax structures. While tax deducted at source (TDS) is not applicable for residents, it is for NRIs.

Some mutual funds, such as ELSS, might have a lock-in period of three years. Consider this while making withdrawals.

Once you decide to make the redemptions, whether directly or through SWP,  the next aspect you must learn about is the tax implication. So, in the next chapter, let us learn about the tax implications of mutual fund redemptions in detail.