Under the SWP option, the mutual fund investor gets a specified amount as a monthly payout.
Bank fixed deposits, Senior Citizens Savings Scheme, and Post Office Monthly Income Schemes are some of the popular investment options for retired and semi-retired people who like to earn regular monthly income. Can mutual funds do the job? Many debt funds as well as some balanced fund offer a monthly dividend option. But remember, dividends are not guaranteed. They are distributed from gains made by the scheme, which is market linked, In other words, dividend payout is determined by fund performance and market movements. Dividends from debt funds are also subjected to dividend distribution tax (DDT) of 28.8 per cent.
When it comes to earning a regular monthly income, experts say SWP or systematic withdrawal plan scores over the dividend option. Under the SWP or systematic withdrawal plan, the investor gets a specified amount as a monthly payout. On a designated date, units amounting to that amount would be redeemed and paid to the investor.
How SWPs work?
Under SWP, the mutual fund will redeem an equivalent amount of mutual fund units from your account based on the prevailing net asset value (NAV).
For example, you have 8,000 units in a mutual fund scheme and you want to withdraw Rs. 10,000 every month through SWP. Now let’s assume that on February 1, the Net Asset Value (NAV) of the scheme is Rs. 20.
The equivalent number of MF units for withdrawing Rs. 10,000 will be 500 (Rs. 10,000 / Rs. 20)
So 500 units would be redeemed from your MF holdings, and Rs. 10,000 would be given to you.
Types of SWP
Fund houses usually offer SWP in two options: Fixed withdrawal and appreciation withdrawal. Under the fixed withdrawal option, the investor specifies the amount he/she wishes to withdraw from the fund on a monthly/quarterly basis. In appreciation withdrawal, the investor can withdraw the appreciated amount on a monthly/quarterly basis.
Taxation of SWP
Investments in debt funds are considered long term only if they are held for more than three years. Currently, the long-term capital gain on debt funds is taxed at the rate of 20 per cent. However, investors get the benefit of indexation on their original investment. This means that the original investment is adjusted for the price of inflation and taxed accordingly. Since the original cost of investment goes up after factoring in inflation, long term capital gains tax comes to negligible levels.
But if debt mutual fund investments are redeemed or sold before three years, the short-term gains are taxed according to the investor’s tax slab.
SWP in debt funds are even tax efficient than fixed deposits even in the first three years of investment. (Read More: Bank FDs Vs Mutual Funds: Which Is Better To Earn Regular Income?)
If you redeem your investments in equity mutual funds through SWP after 12 months, your investments would qualify for long-term capital gains tax which is zero currently. If you sell your equity mutual fund investments before 12 months, you will have to pay a short-term capital gains tax at a flat rate of 15 per cent.
You also need remember that the fund’s exit load (if any) will also apply to the SWP.