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Systematic Withdrawal Plan - A Truly Unsung Offering
Today, fixed deposits or FDs continues 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. A bulk of such investors do not think beyond these traditional products as awareness towards evolved solutions like Systematic Withdrawal Plan (SWP) in mutual funds is lacking. With a mutual fund SWP, an investor can create a reliable pension stream with monthly payouts that is paid on a particular date chosen by the investor without undergoing any fluctuation.
Systematic Investment Plans or SIPs have been success story of the Mutual Fund industry over the last decade, thanks to the continued emphasis shown by the distributor community. However, SWP has been a largely neglected offering. While SIP serves an investor during the accumulation phase and SWP is designed to serve during the distribution phase.
Rupee Cost Averaging - The inside out way
We all know that SIP is a great way to do rupee cost averaging by investing periodically a similar amount irrespective of stock market levels. SWP works similarly but the other way round. Since the monthly withdrawal amount is same, the averaging principle works here too as lower amount of units get redeemed at higher NAV levels and vice versa.
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 products such as hybrid debt funds (MIPs) and hybrid equity funds (balanced funds, equity savings funds) are suitable to opt for SWP. A pure equity fund may be avoided due to its inherent volatility and one may opt for a Hybrid Fund - debt oriented or equity oriented, depending on each individual's risk appetite.
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 8 - 10% p.a. could be suggested in a Hybrid Fund considering the long term return potential.
Tax Impact
It is no secret that debt funds and debt oriented hybrid funds like MIPs do not enjoy tax benefits like equity oriented funds and the dividends are tax-free in the hands of the investors but only after deduction of dividend distribution tax. However, if the investor opts for SWP in the growth option of say MIP Fund, in the initial period of the SWP, the gain portion is much smaller. Most of the payout actually consists of the principal (investment). Over time, the principal component of the payout decreases giving way to the gain component. The short-term capital appreciation (selling price - cost of acquisition) would be taxed at the rate applicable based on the income slabs of the investors. Long-term capital gain would be charged at 20% with indexation. An illustration on the tax efficiency of SWP using NAV of HDFC MIP - LTP- Regular Plan- Growth Option is presented below:
Internal data Computation - The above simulation does not in any manner offer any assured returns and is subject to market risks. The returns (income) shown are assumed figures and not to be constructed as actual returns and/or guaranteed returns. The information provided herein is used to explain the concept and is given for illustrative purposes only. The same is not sufficient and shouldn't be used for the development or implementation of an investment strategy. It should not be construed as an investment advice to any party. Past performance may or may not be sustained in future.
As seen in the illustration, since the tax has to be paid only on the income component, the initial taxable income is very low. Additionally, after 3 years the entire investment becomes a long term asset thereby further enhancing the tax efficiency. This serves a secondary benefit, where-in the unused units appreciate further during the course of the investment thus keeping the end investment value above the original investment. Hence to summarize, as time goes on and the NAV value increases, the principal component per SWP comes down, thereby retaining a larger portion for future capital appreciation.
Most Undersold Offering
SWP is more reliable in terms of cash flows as compared to investing in a fund with monthly dividend frequency as the latter does not assure monthly payouts. With SWP, an investor can plan for cash flow requirements over a long period of time and accordingly set monthly withdrawals from the mutual fund. Today, many mutual funds come with SWP friendly exit load structure allowing redemptions upto 15% of the units without exit loads from the date of allotment. For mutual distributors, SWP is a hidden opportunity to cater to the segment of individuals providing regular pension stream. The benefits of SWP also needs to be highlighted even to younger investors who wish to build a retirement corpus, about the facility which will come handy in future to create monthly pensions. Overall, this offering helps a distributor to have a very long lasting relationship with the investor. Further the distributor community should pitch Retirement Savings Schemes that are specifically designed for creating corpus for the sunset years and that the product can be designed to pump in savings till retirement to start an SWP post retirement.
MUTUAL FUNDS ARE SUBJECT TO MARKET RISKS, PLEASE READ ALL SCHEME RELATED DOCUMENTS CAREFULLY.
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