What is the SWP (systematic withdrawal plan)?
If you want a steady cash flow from your investments, the automatic and traditional choices are fixed bank deposits or postal deposits. However, lower interest rates on these avenues have caused investors to worry about their future income needs. Mutual funds, through their plans, also offer investors an option for these regular cash flows through what is known as the SWP or Systematic Withdrawal Plan. One can set up an automatic redemption on a fixed date of each month or quarter on any of your existing mutual fund investments, providing such a facility.
- You end up paying less tax on the amount withdrawn than if the same amount came back to you in the form of interest on traditional investment products, such as term deposits, postal deposits, etc.
- The SWP is more flexible because it allows you to modify the periodic payment according to your needs. You can go higher if needed or lower which may not be the case in some traditional products.
- In the case of SWPs, you can decide how much you want to withdraw periodically. However, the amount is not fixed in the case of Income Distribution with Capital Withdrawal (“IDCW”) payment options.
- The IDCW option tax is levied on the entire cash flow, regardless of the gain/loss. At the same time, for SWP, one has to pay the appreciated amount for redeemed units only.
- The TDS is levied on the IDCW distribution, which results in additional tax compliance, which is not the case for the SWP, as the tax incidence is entirely in the hands of the investor.
Tax efficiency thanks to the SWP
When the units are redeemed to derive the amount of the SWP, this attracts a capital gain (in case the redemption NAV is greater than the purchase NAV) on the profits made on the sale of the units. Capital gain can be defined as short-term or long-term under the following conditions –
Equity-oriented funds – If redeemed within 12 months of the investment date, they are treated as a short-term gain and taxed at 15%. Gains realized after 12 months from the date of investment are treated as long-term and tax-free up to Rs 1 Lakhs in a financial year. Long term capital gains above Rs 1 Lakh are only taxed at 10%.
Non-equity funds – If redeemed within 36 months (treated as a short-term capital gain) from the date of investment, the gains are added to the investor’s income and taxed at the rate which applies to him. Gains realized after 3 years are treated as long-term and taxed at 20% after deducting the benefits of indexation.