Systematic Withdrawal Plans - An Effective Way to Generate a Second Source of Income
In today's fast-paced world, financial planning has become a crucial aspect of our lives. Whether it's saving for retirement, managing regular expenses, or fulfilling long-term financial needs, investors are constantly seeking efficient strategies to make the most of their investments. Moreover, due to the increasing rate of inflation, a second source of income or supplementary cash inflow may no longer be a luxury but a necessity.
With an additional cash inflow, an investor can spend more time with family and friends, travel early, enhance the standard of living and live an efficient retirement life. Rental income generated through real estate investments and fixed deposits are the most preferred tools when it comes to creating a second source of income.
However, real estate is highly expensive and entails high charges since it attracts hefty taxes, brokerage fees, maintenance charges and other statutory charges. While investing in real estate is very expensive, the process involved in buying and selling is also tedious, time-consuming and cumbersome since it involves a lot of processes. Looking at fixed deposits, there is no scope for capital appreciation, and there is a penalty for premature withdrawals. Both real estate and fixed deposits are low on tax efficiency and attract tax deductible at source (TDS). Further, the post-tax returns on fixed deposits, net of inflation, may even be negative.
Given these drawbacks of real estate and fixed deposits, investors looking for a regular second stream of income may find systematic withdrawal plans (SWPs) in mutual funds to be an excellent option. In this blog, we will explore the concept of SWP, its benefits and how investors can use it to generate a second stream of income.
What is a systematic withdrawal plan (SWP) in Mutual Fund?
Many of us are familiar with the concept of SIP (Systematic Investment Plan), which involves investing a fixed amount of money at regular intervals to build long-term wealth. In contrast to SIP, there is another investment strategy called SWP, where investors systematically withdraw a fixed amount from a scheme instead of investing money at regular intervals.
SWPs allow investors to withdraw a fixed amount from their mutual fund investment at regular intervals, generally monthly. Depending on the needs of the investors, they can either choose to withdraw a set amount or a percentage of the investment. Moreover, the residual investment amount still generates returns hence, while regular withdrawing, investors can enjoy the benefit of the appreciating investment amount. You can also use an SWP calculator to find out how much wealth you would build while also withdrawing from the investment. Just like SIP, SWP also promotes a healthy and disciplined manner of handling finances.
Why SWP?
Mutual fund investments are susceptible to market fluctuations, which can have a negative impact on the fund's Net Asset Value (NAV). This is particularly crucial when approaching a financial need, as the fund returns may fluctuate if not withdrawn in a timely manner. However, with SWP, investors can strategically time their withdrawals to align with their financial needs. If an individual has invested in a mutual fund to fulfil specific needs, SWP serves as an excellent option to ensure that the funds are available when required. By employing SWP, investors can attain their financial objectives promptly without experiencing any cash shortages due to adverse market movements.
Benefits of SWP
- Post-retirement income - SWPs prove to be extremely beneficial for retirees who lack a pension or other regular income sources. It provides them with a reliable and consistent income stream that can effectively manage their post-retirement spending and financial needs.
- Additional source of income - SWP is not limited to retirees, it also serves as an excellent option for anyone who desires an additional source of income alongside their job salary or business profits. By implementing SWP, investors can receive supplementary income on a monthly, quarterly, or annual basis, tailored to their specific requirements. It can even be designed to meet household expenses, retired parent’s support income, kid’s school fees or pocket money and so on.
- Disciplined withdrawals - SWP instils a sense of discipline in investors' approach to managing their investments. Regardless of market conditions or emotional sentiment, SWP systematically withdraws a predetermined number of units from mutual funds each month to cover monthly expenses. This approach acts as a protective shield, preventing impulsive and substantial withdrawals based on market volatility or emotional decision-making.
- Rupee-Cost Averaging - With SWP, a predetermined number of units are redeemed regularly. During favourable market conditions or the bullish phase, fewer units are redeemed, whereas during adverse conditions or the bearish phase, more units are redeemed. This strategy helps to average out returns over time, safeguarding investors from potential financial losses if units are sold during a market downturn.
- Tax Benefits - SWP offers tax advantages for investors. The amount withdrawn through SWP is considered a combination of capital and income. Tax liability is applicable only to the income component and not the capital component. Additionally, SWP withdrawals do not attract TDS, unlike Fixed Deposits (FDs). However, it's important to note that capital gains tax may apply based on the type of scheme and withdrawal amount. For instance
Fund Type Short-term capital gains tax Long-term capital gains tax Debt fund As per the tax slab 20% after indexation Equity fund 15% 10% after indexation
Incorporating SWP into an investment strategy not only ensures a steady income stream but also promotes disciplined financial planning, providing stability and flexibility to investors. Whether it's for retirees seeking post-retirement income or individuals desiring an additional income source, SWP offers an effective and structured approach to fulfilling financial needs and managing cash flow. By considering rupee cost averaging and tax benefits, investors can make informed decisions when incorporating SWP into their investment strategy, ultimately enhancing their financial outcomes.
To conclude, SWPs in mutual funds serve as an effective means of generating a regular income stream. Whether you are an experienced investor or new to the world of financial management, SWP can be a valuable addition to your portfolio. However, it is important to plan SWP implementation carefully, considering your financial needs. A mutual fund distributor can guide you through the entire process of investing as well as implementing SWP to generate passive income, hence, allowing you to enjoy returns while eliminating worries. By incorporating SWP into your investment strategy with the guidance of a mutual fund distributor, you can achieve financial stability and fulfil your long-term needs.
Disclaimer: The information contained herein is only for information and does not constitute, and should not be construed as investment advice or a recommendation to buy, sell, or otherwise transact in any security or investment product or an invitation, offer or solicitation to engage in any investment activity. Mutual fund investments are subject to market risks, read all scheme-related documents carefully before investing.