If you are planning to take a sabbatical from work or are retiring soon, you may be looking at different investment options that give a regular income. Usually, a lump sum is invested to get regular fixed amounts later. Popular products include post office monthly income scheme, Senior Citizens' Savings Scheme and monthly income plans (MIPs). A lesser known option is the systematic withdrawal plan (SWP) in mutual funds. Recently, some funds have even removed the exit load on SWPs if you were to withdraw up to 15-20% in the first year, to encourage people who want to start investing in this instrument. Here is a look at what an SWP is.

WHAT IS SWP?

Many of us would be familiar with a systematic investment plan (SIP), where a corpus is accumulated by making regular investments into a mutual fund. SWP, in essence, is the reverse of an SIP, where you regularly withdraw a fixed amount of money from a lump sum invested in a fund, i.e., you instruct the asset management company (AMC) to redeem units on a predetermined date and credit a fixed sum into your bank account. Your fund's value and number of units will reduce to the extent of each withdrawal. The amount to be withdrawn and the frequency— monthly, quarterly, half yearly, or annually—are set by the investor. Let's say, you hold 25,000 units in a mutual fund scheme. You set up a monthly SWP for Rs.10,000. In the first month, if the net asset value (NAV) of the fund was Rs.25, then, 400 units (10,000/25) will be redeemed from your holding and Rs.10,000 will be transferred to you. You will now hold 24,600 units. In the second month, if the NAV was Rs.26, then 384.62 units will be redeemed, your outstanding units in the fund will reduce to that extent, and Rs.10,000 will be paid to you. This process will continue as long as you run the SWP or till you have completely redeemed your holdings.

Other options such as MIPs that pay dividends do not pay a fixed amount as these are based on the funds' performance.

For an SWP, the tax treatment of each withdrawal will be the same as in the case of full withdrawal of equity and debt funds. Hence, for units where the period of holding has not crossed 12 months for equity funds, short-term capital gains tax will apply. For debt funds, short-term capital gains tax applies if units are held less than 36 months, and long-term capital gains tax if held for longer.

THINGS TO REMEMBER

Although an SWP gives you regular income and saves on taxes in the long term, you cannot open an SWP on a scheme where you have an ongoing SIP. Also, fluctuations in returns can hit your investment and SWP. In a falling market, an SWP can eat into your principal. But some financial planners recommend SWP in balanced funds as typically these are less volatile than pure equity funds.

You also need to be mindful of the fact that the fund's exit load may also apply to the SWP. It can be in the range of 0.25-2%, if applicable and depending upon holding period.