Why SWP may be the Right Solution for Your Periodic Cash Flow Requirement?

While the awareness of SIP has gone up over the years among individual investors, SWP (Systematic Withdrawal Plan) is still relatively unknown.

Today, fixed deposits (FDs) continue to shine when it comes to investment options for those seeking fixed income among other traditional investment products. This does not come as a surprise due to the conservative risk appetite of these investors. Bulk of such investors do not think beyond these traditional products as awareness towards evolved solutions like SWP in mutual funds is lacking. With a mutual fund SWP, an investor could create a reliable pension stream with monthly payouts paid on a particular date chosen by the investor without the withdrawal amount undergoing any fluctuation.

SIPs (Systematic Investment Plans) have been a success story of the Mutual Fund industry over the last decade, thanks to increased awareness. However, SWP has been a largely neglected offering. While SIP serves an investor during the accumulation phase, SWP is designed to serve during the distribution phase. Let us look at a few aspects of SWP.

Rupee Cost Averaging – The inside out way

We all know that SIP is a great way to do rupee cost averaging by investing periodically irrespective of stock market levels. SWP works similarly but the other way round. Since the monthly withdrawal amount is same, the averaging principle works in a systematic way, as compared to larger redemptions on a particular day, which may or may not be favourable for the investor.

Which is the best mutual fund suitable for SWP?

There is no product designed specifically for SWP. Most mutual fund schemes offer this facility as this is simply a mechanism of systematically withdrawing one’s investments on a periodic basis. Generally, lower volatility (as compared to pure equity funds) products such as Hybrid Debt Funds, Hybrid Equity Funds, Balanced Advantage Funds, etc. are suitable to opt for SWP.

What should be the rate of withdrawal?

Again, there is no right rate of withdrawal and hence, on the premise that the investor intends to preserve capital and use the gains component for monthly cash flows, a general yardstick can be derived to fix the rate of withdrawal keeping in mind the long term return potential of a particular fund. For example, a withdrawal rate of 7 – 8% p.a. could be suggested in a Hybrid Fund considering the long term return potential.

Tax Advantage

For an investor opting for SWP, a fixed amount of periodic cash flow is paid out, which consists of 2 portions, principal as well as a gains component. Out of these only the capital gains amount is subject to tax. In contrast, in an interest bearing instrument like an FD, the entire periodic cash flow is the interest component, which is subject to tax. This is a major difference that substantially reduces the tax impact under SWP. Further, if SWP is started immediately after investment, during the initial months of an SWP, the principal component is likely to outweigh the gain component. As the NAV of the underlying fund grows over a period of time, the gain component catches up. The process defers the tax burden for an investor.

SWP scores over IDCW

SWP is more reliable in terms of cash flows as compared to IDCW (Income Distribution cum Capital Withdrawal) payouts as the latter are not assured periodic cash flows and are subject to availability of distributable surplus. With SWP, the investor can choose the exact amount to be withdrawn, which is not possible with IDCW. This allows planning for cash flow requirements over a long period of time.

For investors with a requirement of regular cash flows from investments (predominantly retirees), SWP is an ideal opportunity providing them with a regular pension stream.

Note: HDFC Mutual Fund/AMC is not guaranteeing return on investments made in the scheme and/or by opting for SWP. Investors may note that under SWP there is a possibility that the withdrawals may take place from the principal amount invested. Investors should be aware that the fiscal rules / tax laws may change and there can be no guarantee that the current tax position may continue indefinitely. In view of the individual circumstances and risk profile, each investor is advised to consult his / her financial/tax advisor(s) before making a decision to invest. Unlike traditional investments, mutual fund investments are subject to market risks. Hence, these asset classes are not strictly comparable.

MUTUAL FUND INVESTMENTS ARE SUBJECT TO MARKET RISKS, READ ALL SCHEME RELATED DOCUMENTS CAREFULLY.