Reverse of sip for the retired

When it comes to investing in mutual funds, the most common word that you hear is systematic investment plan (SIP). It refers to investing a small amount at regular intervals to create a big corpus over the long term. However, there is a reverse mechanism called systematic withdrawal plan (SWP), which many investors do not know. In SWP, you invest a big corpus in a fund and withdraw small amounts every month from the account to take care of monthly expenses.

SWP: A brief account

Under SWP, a large sum is invested in a mutual fund scheme and a small amount is withdrawn at a regular interval. The interval of withdrawal is decided by the investor at the time of the investment. It can be monthly or quarterly. Meanwhile, the invested amount keeps growing with per unit cost of the fund, thus replenishing a part or whole of the amount that one withdraws at regular intervals.
Let us illustrate with an example. Mr Srikanth Sahoo invested Rs15 lakh in a balanced mutual fund scheme on January 1, 2015, under the systematic withdrawal plan (SWP). He wants to withdraw a sum of Rs10,000 from the investment on first of every month. By the end of January, the fund value appreciates by 0.65 per cent to Rs 15,09,750. On February 1, Rs 10,000 is withdrawn from the account leaving an outstanding balance of Rs14,99,750.

The withdrawal amount can be a fixed amount as in the earlier example or a part of the appreciated amount. Mutual fund companies usually set a minimum limit, say Rs 500, for the amount that can be withdrawn. If the capital appreciation is less than that limit during a particular interval, no withdrawal would be allowed.Some fund houses even have a higher limit for withdrawal in case of capital appreciation. For example, Birla Sunlife Mutual Fund allows only 90 per cent of the capital appreciation to be withdrawn. The process of setting an SWP is simple. You have to give an instruction (by filling a form) to the fund house, mentioning the amount of money to be withdrawn, the withdrawal interval and the account where the withdrawal amount is to be debited.

taxability, other costs

Depending on the kind of fund you have invested, withdrawal under SWP is liable to short-term as well as long-term capital gains tax. If the money has been invested in an equity fund, there would be short-term capital gains tax of 15 per cent on withdrawals within a year. However, there would be no capital gains tax after completion of one year of investment. Therefore, one can start SWP after one year of investment. This way his withdrawals become completely tax-free. In case of most equity funds, there is an exit load of one per cent on part or full redemption of investments. By deferring the SWP by a year, one can save on exit load as well.

In case of debt funds, short-term capital gains tax is applicable for any withdrawal for three years. After three years, the investor is liable to pay long-term capital gains tax. Short-term capital gains are taxed as per an individual’s tax bracket. For example, if Mr Sahoo falls into 30 per cent tax bracket, any short-term capital gains on his debt fund investments would make him liable to pay a 30 per cent tax. In case of long-term capital gains, the rate of taxation is 20 per cent after adjusting the invested amount to inflation. The tax is not deducted at source and it is the investor’s responsibility to disclose the amount of capital appreciation in income tax return and accordingly pay the tax every year.

Who should opt for SWP?
SWPs are like monthly investment schemes, where you invest a lump sum amount and get a monthly return. All these schemes are mostly used by retired people with a big retirement corpus.
A part of the retirement corpus can be used to start an SWP by investing a lump sum amount in an equity fund, balanced fund (where equity component is more than 65 per cent and hence is considered equity fund for tax purpose) or monthly income plans (a hybrid mutual fund scheme. Other than retired people, SWP can be used by anyone who has a huge lumpsum, and want a regular income from it. For example, a businessman can invest a big corpus in a debt fund and set up an SWP for working capital needs.
(The writer is the CEO of BankBazaar.com)