Systematic Withdrawal Plan

Systematic Withdrawal Plan

Systematic Withdrawal Plan is somewhat similar to Systematic Investment Plan in the sense that it is also done periodically and on consistent basis but it is of exact opposite nature that of Systematic Investment Plan. A Systematic Withdrawal Plan enables an investor to withdraw their investments from mutual funds scheme in a systematic and a phase wise manner. This withdrawal could be done on monthly, quarterly, semi-annually or annually basis. Also, the withdrawal amount could either be fixed or variable in nature. Systematic Withdrawal Plan provides the flexibility to withdraw investments in installments unlike lump sum withdrawals. In Systematic Withdrawal Plan, an investor channelize their investment from the plan to the savings account. This strategy is aimed at dealing with market fluctuations. Systematic Withdrawal Plan lets an investor to modify the cash flows as per their needs Investor may decide to either redeem just the capital gains on their investment or the fixed amount. In this way, investor shall not only have their capital still invested in the mutual fund scheme, but will also be able to use regular returns and income. The capital that an investor withdraw could either be reinvested in another fund or could be retained by him in the form of cash.

When an investor select a Systematic Withdrawal Plan, it influences his mutual fund account as well. It is vital to observe that a Systematic Withdrawal Plan is not as similar as opening a fixed deposit bank account where the investor receives monthly interests on regular basis. In the fixed deposit scheme, the invested principal value is not affected when an investor redeem the interest amount. However in the scenario of systematic withdrawal plan in mutual fund schemes, the amount of investor’s fund is declined by the number of units withdrawn.

To understand the concept of Systematic Withdrawal Plan thoroughly let us take an example.

Suppose an investor Pawan has 6,000 units in his mutual fund scheme and he wish to withdraw Rs 3,000 every month using his Systematic Withdrawal Plan. Take an assumption that the Net Asset Value of the scheme is Rs 30. The redemption of Rs 3,000 from this scheme will imply that 100 units are being sold, which is Rs 3,000/NAV of Rs 30. The residual units in investor’s mutual fund after the redemption shall be 5,900 units (6,000-100). At the beginning of the next month if the Net Asset Value of investor’s scheme increases to Rs 50, then the redemption of Rs 3,000 would mean selling 60 units, which is Rs 3,000/NAV of Rs 50. The mutual fund would be left with 5,840 units after this redemption (5,900-60). Thus, with each withdrawal, investor’s mutual fund will see a reduction in its units. At higher NAVs, investor might withdraw fewer units to meet the cash needs. On the other hand, as the NAV declines, it would have the contrarian effect, mandating the withdrawal of more units. A crucial aspect of making most use of this plan and gaining from it is by planning the Systematic Withdrawal Plan, and focusing on investor’s needs, objectives and end goal. The Systematic Withdrawal Plan might have an adverse impact on the value of investor’s fund if he opts for unplanned and unsystematic withdrawals.

The Systematic Withdrawal Plan has the following benefits:

  • The Systematic Withdrawal Plan instils the habit of discipline in the investor’s attitude. It automatically withdraws some mutual fund units every month to meet investor’s monthly expenses, irrespective of market levels. It thereby, protects investors from withdrawing vast amounts due to fear or panic during the times of market crash. It also withdraws capital even when markets are setting new record highs and thereby, protects investors from the impulse feeling to invest more capital during the boom periods.
  • The Systematic Withdrawal Plan assist investors to take advantage when they withdraw their investments due to rupee cost averaging. The technique of Rupee cost averaging provides an investor the average Net Asset Value of a mutual fund spanning over several months or years instead of making him dependent on a Net Asset Value at a single point of time. The investor benefits as he or she decides to redeem through Systematic Withdrawal Plan rather than redeeming a lump-sum amount in one go as the previous option provides the benefit of rupee-cost averaging. The phase wise withdrawal gives investor monthly cash-flows and gives his capital a longer time period to multiply.
  • The Systematic Withdrawal Plan supports an investor by getting a fixed regular amount which can help him or her in managing his or her children’s educational expenses or in getting a proper income in his or her retirement years.
  • Market Fluctuations directly affect investors’ mutual fund investments. This also implies the fluctuations might impact the fund Net asset Value adversely. When an investor is nearing his or her financial goals, the fund returns might disappear if not redeemed on timely basis. Systematic Withdrawal Plan can help in timing investor’s withdrawals as per the individual financial needs. If investor’s goal is supposed to be funded in a phase wise manner, then investor can opt for a Systematic Withdrawal Plan. It will make sure that the funds are available at the appropriate time. In this way, goal accomplishment might not get postponed because of a cash crunch. Systematic Withdrawal Plan also assists investors who look for a second source of income apart from their regular salary from the job. With this plan an investor can create a flow of income from their investment that is regular. If he or she seeks to have periodic incomes for their travel or other needs, this is a wonderful way to set this provision. It should be set in such a way that when the investor needs cash the most, it is available.
  • Every withdrawal done through the Systematic Withdrawal Plan is treated to be a combination of capital and income. Tax is payable only on the income portion and not on the capital portion. For instance, suppose that Mr Jagan has invested Rs 5 lakh in a mutual fund and this grows to Rs 6 lakh (20% growth). He redeems Rs 50000 from his mutual fund at the end of every year. Only 20% of his withdrawal (Rs 10,000) is considered as income and the balance (Rs 40,000) is considered as capital withdrawal. On the other hand, if he had invested in a bank Fixed Deposit and got Rs 1 Lakh interest on a principal of Rs 5 lakh, the entire Rs 1 lakh would be considered as income and would be subject to tax.
  • The Systematic Withdrawal Plan can also be made more tax efficient if it splits investor’s income over several years. For instance, both Mr. Amit’s and Mr. Sumit’s total taxable income for FY19 and FY20 is Rs. 4,50,000 without considering their mutual fund capital gains. For ease of understanding, suppose both Mr. Amit and Mr. Sumit invested in the debt mutual fund scheme earned monthly gains of Rs. 10,000 throughout FY19 and FY20. While Mr. Amit decided to opt for a monthly Systematic Withdrawal Plan and redeemed the capital gain for 10 months starting October 2018, Mr. Sumit decided to withdraw Rs. 1,00,000 in July 2019. Now, thanks to Systematic Withdrawal Plan, Mr. Amit was able to keep his total taxable income within the tax bracket of Rs. 5,00,000 (Rs. 4,50,000 + Rs. 50,000) and pay his tax at the rate of 5% for both FY19 and FY20. While, thanks to the lump sum redemption in July 2019, Mr. Sumit’s total taxable income increased to Rs. 5,50,000 in FY20, hence attracting tax at the rate of 20%.

Taxation plays a crucial role in redemption through a Systematic Withdrawal Plan. In case of debt funds, if investor’s holding period is less than 3 years, then the amount that investor redeem shall form a part of investor’s income. It will then be taxed according to investor’s income slab. On the other hand, if the holding period is more than 3 years, then the long-term capital gains will be taxed at 20% with indexation. In case of equity funds, if investor’s holding period is less than 1 year, then the redemption amount will be taxed at the rate of 15%. On the other hand, if the holding period is more than 1 year, then the long-term capital gains will be taxed at 10% without indexation. An open-ended fund gives investor an option of withdrawing the investment or adjusting it at any time. Let us also understand why Systematic Withdrawal Plan is a wise investment strategy. These redemptions are not subject to tax deductions at source. Although the capital gains are taxed on the redeemed amount. Investors might also opt for setting up their withdrawal in such a manner that they only draw the appreciation that is made on their investment amount. This keeps their money invested while at the same time, they enjoy the gains on periodic basis.

  • What is a Systematic Withdrawal Plan?
  • A Systematic Withdrawal Plan enables an investor to withdraw their investments from mutual funds scheme in a systematic and a phase wise manner. This withdrawal could be done on monthly, quarterly, semi-annually or annually basis.

  • How does the Systematic Withdrawal Plan function?
  • When an investor select a Systematic Withdrawal Plan, it influences his mutual fund account as well. It is vital to observe that a Systematic Withdrawal Plan is not as similar as opening a fixed deposit bank account where the investor receives monthly interests on regular basis. In the fixed deposit scheme, the invested principal value is not affected when an investor redeem the interest amount. However in the scenario of systematic withdrawal plan in mutual fund schemes, the amount of investor’s fund is declined by the number of units withdrawn. At higher NAVs, investor might withdraw fewer units to meet the cash needs. On the other hand, as the NAV declines, it would have the contrarian effect, mandating the withdrawal of more units.

  • What are the benefits of the Systematic Withdrawal Plan?
  • The Systematic Withdrawal Plan has some of the benefits such as Discipline, Rupee Cost Averaging, Fixed Regular Income, Strategy to deal with Market fluctuations and Taxation benefits.

  • Which strategy is better Systematic Withdrawal Plan or lump sum Withdrawal?
  • The investor benefits as he or she decides to redeem through Systematic Withdrawal Plan rather than redeeming a lump-sum amount in one go as the previous option provides the benefit of rupee-cost averaging. The phase wise withdrawal gives investor monthly cash-flows and gives his capital a longer time period to multiply.

  • What are the provisions related to taxation in Systematic Withdrawal Plan?
  • Taxation plays a crucial role in redemption through a Systematic Withdrawal Plan. In case of debt funds, if investor’s holding period is less than 3 years, then the amount that investor redeem shall form a part of investor’s income. It will then be taxed according to investor’s income slab. On the other hand, if the holding period is more than 3 years, then the long-term capital gains will be taxed at 20% with indexation. In case of equity funds, if investor’s holding period is less than 1 year, then the redemption amount will be taxed at the rate of 15%. On the other hand, if the holding period is more than 1 year, then the long-term capital gains will be taxed at 10% without indexation. An open-ended fund gives investor an option of withdrawing the investment or adjusting it at any time.