How to Sensibly Use the SWP Option for Your Retirement Planning

All of us wish to lead a peaceful retired life free from financial worries.

To achieve this, proper retirement planning is of utmost importance. This is because your regular source of income will come to a halt once you retire.

Interest rates on traditional avenues such as bank fixed deposits and other small-saving schemes have declined. You cannot fully rely on them for your future needs.

So, when you start planning for your post-retirement life, choose investments that can not only protect your capital but also compound wealth, and counter inflation.

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As regards cash-flow post-retirement, the Systematic Withdrawal Plan (SWP) option of mutual funds is an effective way to earn regular income.

What is the SWP option of mutual funds?

SWP allows you to withdraw a fixed amount at pre-determined regular intervals (say monthly, quarterly, half-yearly, or annually) from the money parked in your equity and/or debt mutual funds.

You also get the option to withdraw only the appreciated amount at the interval set by you. Meanwhile, the remaining units in your scheme continue to grow over time, thereby helping you beat inflation.

Thus, SWP not only provides you with a fixed source of income but also inculcates a disciplined approach to spending. It's an ideal option for investors seeking regular income from their investments, such as retirees.

Here's why the SWP option is better than the dividend option to plan for systematic cashflows...

It's a common perception among many investors that the Income Distribution cum Capital Withdrawal (IDCW) option of mutual funds, erstwhile Dividend option, will help them earn regular income or cashflows.

But the fact is that declaration of dividends is not mandatory or guaranteed. They are declared only at the discretion of the fund house.

Unlike the Growth option, where the profits are re-invested in the scheme when you choose the IDCW (Dividend) option, the scheme can distribute a portion of the profit to investors. The NAV of the scheme falls to the extent of dividend distribution.

Since the profits are not re-invested in the scheme in the case of the Dividend option, it could put the brakes on the process of compounding wealth.

Besides, the income distributed as dividend is taxable as per the income tax slab of the investor. While this can prove to be beneficial for investors in the lowest tax slab, if you are in higher tax brackets, it can be a disadvantage from the taxation point of view.

The IDCW payout is also subject to TDS @10% in the hands of the recipient if the total dividend amount exceeds Rs 5,000. This implies that relying on dividends is not a prudent approach to earn a regular income.

On the other hand, there is no TDS deducted when you withdraw through the SWP route.

The following are the benefits of opting for SWP:

• Facilitates better planning of withdrawals, as per your need

  You can choose the date, frequency, and amount of withdrawal depending on your invested corpus and estimated periodic expenses. SWP can be continued as long as there are balance units in the scheme or till the end of SWP tenure.

  Further, as an investor, you can also stop the SWP at any point, increase/decrease the withdrawal amount, and even add fresh investments to the scheme.

• Enables rupee-cost averaging as the units are not redeemed in one go

  Redeeming mutual fund units regularly via SWP makes timing your redemption irrelevant as you benefit from rupee-cost averaging. Though more units will be redeemed in a falling market, you will benefit when the market bounces back.

  During market uptrends, fewer units will be redeemed as against when markets are on a downward trend. This allows you to book profit through withdrawal while the investment value of the remaining corpus appreciates.

• Benefit from the power of compounding and counter inflation

  SWP inculcates a disciplined approach to withdrawing from mutual funds. Only a certain amount is withdrawn regardless of the market conditions.

  This ensures that your retirement money lasts long and is not prematurely exhausted. The units not withdrawn, continue to grow over time and compound your wealth, enabling you to counter inflation.

How SWP can ensure a regular and systematic cash inflow for retirees

If you are looking to rely on mutual funds for your post-retirement expenses, ensure that you have built a sizeable investment corpus. Once you retire, set up SWP to withdraw a fixed amount regularly for your expenses.

Here is how it will work...

Let us assume that you have accumulated a mutual fund corpus of Rs 5 lakh as of January. The NAV of the scheme is Rs 100. So you will get 5,000 units. Now, if you withdraw Rs 10,000 every month, your holding will decline to 4,903 units (i.e. Rs 10,000 / Rs 100 NAV = 97 units are reduced from his initial holdings) in the first month of SWP i.e. February.

Table: How SWP can ensure regular cash inflows for retirees

Month	SWP Amount	NAV	Units redeemed	Units left	Fund Value
January	--	100	--	5,000	500,000
February	-10,000	103	-97.1	4,903	505,000
March	-10,000	102	-98	4,805	490,097
April	-10,000	105	-95.2	4,710	494,512
May	-10,000	108	-92.6	4,617	498,641
June	-10,000	106	-94.3	4,523	479,407
July	-10,000	107	-93.5	4,429	473,929

Note: The above table is for illustration purposes only
(Source: PersonalFN Research)

Over six months, even after withdrawing a total of Rs 60,000, the total value of your portfolio will be Rs 473,929 due to market dynamics.

This effectively proves SWP's worth as a better earning instrument vis-a-vis lump-sum withdrawal.

In short, under SWP, you will benefit even when you withdraw while the remaining units continue to grow and appreciate the investment value. Hence to address your cash-flow needs during retirement, consider the SWP option.

To conclude

Ideally, prefer mutual fund schemes for SWP that are suitable to your risk profile and investment objective.

Some schemes are prone to higher volatility and can suffer heavy capital losses during bearish market phases. Therefore avoid taking a higher risk to generate higher returns that can impact your plans for a blissful retirement.

Set realistic expectations from your invested corpus. Otherwise, you will end up depleting your corpus sooner than expected.

Another important point to remember is that withdrawal through SWP is considered as redemption. Therefore it can attract exit loads and/or taxes. This will depend on the holding period and whether the scheme is equity-oriented or a debt-oriented mutual fund.

In the case of an equity-oriented mutual fund, the gains realised on the units held for a period of 12 months or more, a Long Term Capital Gain (LTCG) tax will apply. LTCG is taxed at a rate of 10% only if the capital gains are over Rs 1 lakh.

For gains realised on equity mutual fund units held for a period of less than 12 months, Short Term Capital Gain (STCG) applies. STCG on equity mutual funds is taxable at a rate of 15%.

On the other hand, gains realised on debt mutual fund units held for less than 36 months are Short Term Capital Gains. STCG on debt mutual funds is taxable as per one's income-tax slab.

Gains on debt mutual fund units held for 36 months or more are classified as Long Term Capital Gains (LTCG). The LTCG on debt mutual funds is taxable at the rate of 20% with indexation benefit.

The indexation benefit allows you to adjust the purchase price of debt funds for inflation, thereby reducing the tax outgo.

The path to your blissful retired life will depend on taking prudent investment decisions in the interest of your overall financial wellbeing.

So, invest sensibly after understanding the risk-reward matrix. Make sure to diversify your investments across asset classes and investment avenues to mitigate the impact of dynamic market conditions.

Disclaimer: This article has been authored by PersonalFN exclusively for Equitymaster.com. PersonalFN is a Mumbai-based Financial Planning and Mutual Fund research firm known for offering unbiased and honest opinions on investing.