As you are aware that Systematic Withdrawal Plan (SWP) is one of the best saving instruments to secure your monthly income. A SWP is a mutual fund plan in which you deposit hefty amount and request the fund manager for withdrawal of some amount from SWP monthly so that you will pay your monthly expenses and balance of your fund will be managed by the fund manager and grow continuously with the growth of the market.
Every individual has different financial need. Hence, every investor has a unique investment plan. While some investors prefer investing in a lump sum, some others like to stagger their investments and use a systematic investment plan (SIP).
While some investors seek capital growth, some others want regular income from their investments. There are many tools facilities extended by fund houses to meet the expectations of different types of investors. One such facility is a Systematic Withdrawal Plan (SWP).
WHAT IS AN SWP?
A Systematic Withdrawal Plan or SWP is a facility extended to investors allowing them to withdraw a fixed amount from a mutual fund scheme regularly. You can choose the amount and frequency of withdrawal. You can also choose to just withdraw the gains on your investment keeping your invested capital intact. At the set date, units from your portfolio are sold and the funds are transferred to your account.
From above it is clear that in SWP you invest and get growth in your investment and monthly withdrawal also.
But important thing to consider is that, who to pay tax on monthly withdrawal from SWP.
Let’s discuss.
Let us say you invest Rs 1 lakh in a mutual fund. It grows to Rs 2.5 lakh in X years. You decided to sell your holdings and make a nice profit of Rs 1,50,000. However, your net profit will not be one lakh fifty thousand. You need to pay the taxes.
How much goes to the taxes depends on two points:
- What kind of mutual fund did you hold?
- What was the holding period?
As an investor, you must understand the tax implications before investing in any mutual fund. It will help you determine your absolute returns.
SYSTEMATIC WITHDRAWAL PLAN: MUTUAL FUND TAXATION
Let us first understand the Systematic Withdrawal Plan (SWP). SWP is a feature offered by mutual funds that allows you to withdraw a predetermined amount of money from your investment at regular intervals. SWP is particularly useful if you look to generate a regular income stream from your mutual fund investments while keeping the investment intact.
The taxation of SWP mutual funds will depend on the category. For example, if you have invested in an equity mutual fund, the taxation rules similar to equity will apply.
WHAT ARE THE RULES?-EQUITY MUTUAL FUND:
The gains on your investments if withdrawn in the first year are treated as Short Term Capital Gains (STCG) and taxed at 20%.
If the investment is redeemed after the first year, the gains are called Long Term Capital Gains (LTCG) and are taxed at 12.50%.
Let us understand how it will work out in SWP.
Let us say you invest Rs 5 lakh in a mutual fund on 1st January 2024 and set up a SWP plan to withdraw Rs 10,000 monthly. For simplicity, let us assume that NAV was Rs 100, so you got 5000 units. On the 1st of February, the market increased by 10% (highly unlikely, but an assumption for easy understanding).
The value of your NAV increased to 110. For 10,000 income, approximately 91 units are sold.
Your gain in this first can be calculated as below (approx values):
- Initial Investment in 91 units: Rs 9,100
- Withdrawal Value of 91 units: Rs 10,000
- Capital Gain: Rs 900
Since the withdrawal happened within a year, you need to pay a 20% tax on the amount, which comes to be Rs 180.
If the market had corrected by 10% in the same period, there would be losses. Let us say that NAV came down to Rs 95 per unit at the end of the first month. In this case, the AMC needs to sell 105 units to give you Rs 10,000.
- Initial Investment in 105 units: Rs 10500
- Withdrawal Value of 105 units: Rs 10,000
- Capital Loss: Rs 500
You can offset these losses with gains. You can offset short-term capital loss against long- and short-term capital gains.
The calculation will continue similarly. After one year, the tax will be reduced to 12.50%.
In a financial year, your net gains will be calculated, and you pay tax on it. In the case of LTCG, if the total gain is less than Rs 1.25 lakh, you don’t need to pay any tax.
DEBT FUND MUTUAL: SWP EXAMPLE
If you have invested in a debt mutual fund and opted for SWP. The gain/loss will be calculated as mentioned above. The net gains get added to your income and taxed as per your tax slab. It means that income or withdrawal from Debt Mutual Fund SWP is always considered as Short-Term Capital Gain/Loss and will be included in your income and tax will be paid as per your income tax slab.
IDCW MUTUAL FUND: TAXATION
DCW stands for Income Distribution cum Capital Withdrawal. It refers to a type of dividend option offered by the mutual fund, where the fund periodically distributes a part of its income (dividend) to the investors, and if there are any capital gains, they are distributed as well. The tax treatment of IDCW depends on the nature of the income being distributed. For example, dividends from equity-oriented mutual funds were subject to Dividend Distribution Tax (DDT) until it was abolished in the Finance Act 2020.
After the abolition of DDT, dividends are now taxable in the hands of the investors at their respective income tax slabs. So, these funds are not beneficial for investors who fall in the 20 or 30% tax slab.
GROWTH PLAN: TAXATION
The growth plans of mutual funds are taxed similar to what we have discussed in the SWP option. Here, you are not making regular withdrawals.
If you withdraw within the first year, you pay STCG at 20%.
After one year, the gains are taxed at 12.50% for gains over Rs 1.25 lakh.
WAYS TO SAVE TAX: TAX LOSS HARVESTING
Tax loss harvesting is a strategy used by investors to offset capital gains by selling investments that have incurred losses. This allows investors to minimize their tax liability by using the losses to offset taxable gains.
Here’s an example using a hypothetical mutual fund investment:
1.Let us say you invested in a mutual fund and bought 1,000 units at Rs. 100 per unit, resulting in a total investment of Rs 100,000.
Now, the market value of the mutual fund has decreased, and the current unit price is Rs. 80. The current market value of your investment is:
- Market Value: 1,000 units at Rs 80 = Rs 80,000
In this scenario, if you sell your units, you will incur a loss of Rs 20,000
2. Now, you have another investment in a different mutual fund that has gained Rs 20,000 during the same period.
- Purchase: 1,000 units at Rs. 50 = Rs 50,000
- Market Value: 1,000 units at Rs. 70 = Rs 70,000
In this case, you have a capital gain of Rs 20,000
Now, to offset the capital gains, you decide to sell the units from the first fund that have incurred a loss. By selling the units at a loss, you can use that loss to offset the capital gain and reduce your overall tax liability. In this case, your net tax liability becomes zero.
CONCLUSION: SWP is one of the best Mutual Fund Plan to get regular income and increased / appreciation in your investment portfolio. Please note that withdrawal from SWP is taxed according to nature of SWP whether Equity or Debt Plan. Please plan accordingly and invest before considering all taxation aspects of SWP before investing. Because taxes play a major role in growth and return on your investment.
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DISCLAIMER: article presented here is only for sharing information wit readers. The views expressed here are personal views of the author, shall not be considered as professional advice. In case of necessity do consult with professionals.
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