First, let us try to understand what ‘SWP’ is. SWP stands for Systematic Withdrawal Plan, which is a means of redeeming your mutual fund holdings. You provide the mutual fund (in which you have invested) a standing order to redeem a specific amount from the fund on a regular basis. The frequency is normally monthly, however it can be changed to whatever is most convenient. For example, suppose you have investments in some 5 funds managed by different asset management companies. You wish to withdraw SWP from 3 of these funds right now while keeping the other two funds untouched. Depending on your investment corpus and your needs, you can request a withdrawal or redemption of Rs. 20,000 per month from fund ‘X’, Rs. 15,000 per month from fund ‘Y’, and Rs. 10,000 per month from fund ‘Z’.
SWP may be applied by any investor, although it is particularly suitable for planning one’s retirement. Retired persons who do not have an active source of income use this SWP strategy for their monthly cash flow needs. This method allows for flexibility. The amount to be withdrawn in a SWP can be raised or lowered as needed. If an SWP is no longer necessary, it can be discontinued. If a fund has been failing to perform for an extended period of time, it is possible to take out a lump sump amount or maybe quit the fund entirely and withdraw the entire amount.
Taxation:
Now let’s look at the tax effects for this SWP.
As you are mindful, any appreciation in your invested capital within a one-year holding period in equities is referred to as Short-Term Capital Gains (STCG). STCG is taxed at 15% (plus the surcharge and cess as applicable).
Long-term capital gains (LTCG) are taxed when equities are held for longer than a year. LTCG is taxed at 10% plus the surcharge and cess. However, we need to note that LTCG applies to capital gains of greater than Rs. 1 lakh every financial year. As a result, LTCG of up to Rs. 1 lakh is tax-exempt.
For lump-sum one-time investments and redemptions, capital gains for tax purposes are calculated as the fund’s exit net asset value (NAV) less the entry NAV. The next question that may come in our mind is how this is calculated for monthly or quarterly SIPs, as we shall invest multiple times. So in this case of SIPs, capital gain is calculated for a sequence of entries and/or exits using the ‘First in – First out’ (FIFO) method.
Hence, if you made a lump sum investment in the fund, the multiple exit NAVs of your SWP will be compared to the entrance NAV to calculate capital gains. If you previously completed a systematic investment plan (SIP) and are now implementing an SWP, each redemption NAV will be matched with the earliest SIP investment (first in) for capital gains.
So, to take full advantage of LTCG, your SWP should begin one year after you first invested in the fund.
Depending on your needs, you can try to regulate your SWP amount such that capital gains are less than Rs. 1 lakh every fiscal year (Rs. 1 lakh that we are talking about here is the capital appreciation in a year and not the quantum of withdrawal per year).
As an example, assume that your initial capital investment in an equity mutual fund at the applicable entry NAV is Rs. 5 lakh. The market value at exit NAV is Rs 5.6 lakh. In this situation, the principal amount of your SWP is Rs. 5 lakh, while the capital gain is Rs. 60,000. Given that all settlements are made after having the equity mutual fund been held for more than one year, the profits are excluded from tax for that year if they are less than Rs. 1 lakh. Your cash flows, assuming a monthly SWP, are Rs. 5.6 lakh/12 = Rs. 46,667.
Even if the withdrawal amount is larger, you will be taxed on LTCG exceeding Rs. 1 lakh for that year. If you can limit the withdrawal quantum to Rs. 1 lakh, your SWP will be tax-free.
If you can manage taxes efficiently as discussed above, you can enjoy your retirement corpus entirely, without the burden of heavy tax cuts.
Withdrawal quantum:
The standard approach that investors follow to determine the SWP amount is to restrict it to the mutual fund’s profits or returns. People try to forecast the fund’s profits, let us say 10% return each year, and only withdraw a set amount of 10% of the corpus through SWP. However, the concept here is that the principal portion of the retirement corpus may be impacted during withdrawal, and this is due to the fact that the market could have dropped in a particular year, and hence withdrawing 10% will actually reduce your invested principal portion.
But if you are a senior citizen, you can try to use or allow withdrawal of the principal component as well, as this is your own retirement corpus, and it represents all you worked for during your working life. Unless you intend to leave an inheritance fund for your future generations, it is completely fine to use the principal portion of your invested capital for your needs.
You have to roughly figure out your life expectancy, the approximate amount of remaining years, the mutual fund’s expected profits, and how much of the invested corpus you intend to withdraw each year. I can understand that it is difficult to predict our life expectancy; at least we can try to assume Indian lifespan average of 80 years as our life expectancy as well.
We must remember that our retirement fund should last for our remainder amount of years. For example, if you are 60 years old and have a life expectancy of 80, you can take a certain amount of principal every year such that the remaining (invested) amount, together with profits, will last you the following 20 years or beyond. Always try to have a cushion or headroom here, so that you are not running short of funds even if you outlive the average life expectancy.
