Understanding & using SWP effectively

Saving and investing is a big part of your financial plans. Sometimes, even planning for your cash outflows becomes a vital component of your financial plan. If you are looking for regular and predictable cash flow from your investments then the automatic choice for most of us would be the traditional avenues like bank FDs and postal deposits. However, the falling /low-interest rates on these schemes and inflation have made people worry about their future. The big questions are, will the cashflows it be sufficient and how long will the investment last?

Against this backdrop, Systematic Withdrawal Plans (SWPs) offered by mutual funds are increasingly gaining popularity and can be a great choice for investors looking to generate cash flow from their investments at a regular frequency. In this article, we shall dig deeper to know more about SWPs.

What is SWP?

Most of us are aware of SIP (Systematic Investment Plan) for creating long-term wealth. The SWP (Systematic Withdrawal Plan) is like the reverse of SIP wherein instead of investing money at regular intervals, investors withdraw/redeem a fixed amount from a scheme in an automated way.

The SWP serves as a perfect tool for planning for that phase in your life where you are dependent on cash inflows, for whatever reason. Here, the investor would usually make an initial investment in the chosen fund and then plan for SWP, either immediately or starting at a later date. The investor has the flexibility to customize the amount, the withdrawal frequency and the period of withdrawal - fixed instalments or till the balance is available in the fund. The investment lying in the fund would continue to grow, generating wealth for the investor, helping beat inflation and making sure that the fund lasts longer and the SWP continues for a longer period of time. The SWP is also a smarter and more tax-friendly way of withdrawing money. 

When can SWP be used?

1] Retirement planning /creating own pension 

A very common use of SWP is in retirement planning. Here, a part of the retirement corpus is invested in a hybrid scheme, with a mix of both asset classes - equity and debt, giving the best of both worlds. The equity is for the long term, for that extra boost of growth and the debt is usually for short-term safety. The choice of the fund category and scheme, however, depends on your needs, the risk profile, and the investment horizon, before the start of SWP. 

2] Creating a secondary source of income

A SWP can also be started in financial situations where there is a temporary need to supplement your income, like the recent pandemic. If you have adequate investments, an SWP could be used to meet your temporary financial needs. Also, instead of withdrawing a big amount in one go, one can smartly use SWP to maintain some stability in your spending. Note that in times when you have surplus cash inflows, aggressive savings should be done using SIP instead of withdrawing with SWP. 

3] Meeting specific cashflow needs for someone 

Another smart use of SWP would be in scenarios where you invest and dedicate a corpus for a specific objective/regular expense and an SWP is created to finance the same. The corpus would keep growing slowly while small withdrawal amounts would be credited to the bank account and from this, the intended expenses would be met. Even these expenses can be automated to ease your life. As an investor, you would only need to keep track of the fund balance from time to time and replenish it, if required. There can be many scenarios where such an approach can be used in financial planning. A few examples are cited below.

• Investing on behalf of children and then having SWP for education fees and pocket money 
• Investing on behalf of the wife and then having SWP for monthly household expenses, etc.
• Investing on behalf of dependent parents and then having SWP for meeting their expenses 

The right withdrawal rate:

This is an interesting question. What should be your sustainable or safe rate of withdrawal in order to make sure that your fund lasts for the required period of time and even longer? A complementary question would be, what should be my investment corpus to have the desired stream of money last for the required period of time? This is in fact at the heart of everyone trying to retire early and for those who are reaching retirement soon. 

The withdrawal rate is the percentage of corpus you intend to withdraw every year. So a 4% rate on a corpus of Rs.25 lakhs would mean that you are withdrawing Rs.1,00,000 every year (Rs.8,333 monthly). Obviously, the lower the withdrawal rate and the higher the investment corpus, the better. Also, the expected returns from the fund also matter in replenishing itself and growing to finance withdrawals for a longer period of time. While a rate of up to 3-4% may be considered safe, a lower rate can help account for market volatility, uncertainties and lifestyle improvements. The withdrawal rate should be as per your need - a higher rate would mean that your corpus gets exhausted early and a lower rate would be insufficient.

Benefits of SWP: 

a] Rupee Cost Averaging: Just like SIP bring discipline in investing, SWP brings discipline in withdrawals. You also benefit from rupee cost averaging with SWP, since a fixed amount is redeemed on a regular basis and one is not too much concerned about market volatility. With SWP, redemptions will be spread out evenly and it will protect you when redeeming a large amount at a time when markets are low. 

b] Tax Benefits: The amount withdrawn in an SWP consists of the original investment and the capital gains, on which there is tax liability. The capital gains tax is payable only on the portion withdrawn, unlike traditional investments where the entire interest generated on the investment is taxable on an accrual basis. Further, there is no TDS deduction on SWP withdrawals. With mutual funds, you can enjoy better tax treatment compared to traditional investments. 

To Conclude

SWP is an efficient and optimal way to plan for regular cash inflows. However, one must be careful and keep the financial objectives in mind. Remember, unplanned and unnecessary SWPs can cut short your wealth-creation journey. Get in touch with your mutual fund distributor today, to plan the right investment strategy, suited to your needs. Happy investing!