How to Plan Retirement With SWP | Mutual Fund SWP vs Annuity

How to Plan Retirement With SWP | Mutual Fund SWP vs Annuity


How to Plan Retirement With SWP | Mutual Fund SWP vs Annuity
How to Plan Retirement With SWP | Mutual Fund SWP vs Annuity
SWPs offer a steady income stream, making them an excellent option for investors. Further, the rates of return are tax-efficient, and there are no taxes deducted on gains, making them a good choice for investors looking for a fixed income.

A word like "Retirement" triggers mixed emotions in us. It seems that we were born yesterday and must retire tomorrow. Yes, that's true! Time passes quickly, and it is essential to focus on what we can do to minimize future financial problems.

The most important thing you can do is start planning your retirement now since you will never know when the golden years will arrive. After all, you retire from your job, not from life.

Also, you may have new dreams when you retire. Therefore, maintaining your daily lifestyle will be essential but spending less will be preferable.

Fortunately, as we move towards retirement, we have an array of choices available in the market for financial planning. These include investment plans like MF SWP, PPF, EPF, NPS, etc.

Unfortunately, this concept is not very well known in our country.

This article aims to explain SWP, how it works, and what it can offer. Before we continue, you may want to learn what SWP actually is to understand the context better.

What is SWP? 

Systematic Withdrawal Plans allow for periodic withdrawal of mutual fund schemes, e.g., partially or entirely. This way, the cash flow can be tailored to your specific needs. Regularly investing through an SWP is similar to building investments through a SIP.

Redemption may be requested monthly, quarterly, half-yearly, or annually. Investment withdrawals are based on the amount specified by the investor. If an amount is set based on the NAV, the fund must sell the required number of units and then refund the investor.

Having read SWP, let's explore its types.

Types of SWP

There are two types of SWP based on their withdrawal options:

Fixed withdrawal plan

Under this plan, an investor can sell the allocated units to withdraw a specified amount at regular intervals.

Capital appreciation

In this scenario, the appreciated amount or the profits are deposited into an investor's account at the stated date or time.

Also, Read Why should you invest in Index Funds?

Benefits of a Systematic Withdrawal Plan (SWP)

The following are a few benefits SWP offers:

Tax Benefits

In case investors want to earn regular income from their investment, they can choose an option that offers dividends or an SWP. A dividend distribution tax is deducted at the source when dividends are distributed. 

If you receive dividends, you don't have to pay any tax on them. The dividend distribution tax is 10 percent. Conversely, if you choose an SWP, no tax is deducted from your paycheck at the source. In general, capital gains tax will apply to different types of plans.

Rupee Cost Averaging

Rupee Cost Averaging applies to the purchase and redemption of units in installments. The timing of all your units' redemption must coincide with a favorable market environment since the markets are volatile. Make sure that you book healthy profits before selling, since if you do that during a slump, your profit may be skewed.

Regular income flow 

An SWP can provide retirees with a steady income. The performance of the fund and the type of investment scheme an individual invests in also impact the returns one can earn.

Redeem required money

By using SWP, individuals can redeem only their required funds and keep their surplus investment funds. As a result, individuals adopt a withdrawal habit, thus preserving their investments.

Discontinue as needed

SWPs can be halted at any time and the entire amount redeemed if necessary. By contrast, redemption would be more challenging if the money were invested in a fixed deposit or another avenue of investment with a lock-in period.

Pension substitute 

SWPs can be used to replace pensions when an individual retires. As a result, pensioners can rest easy knowing their investments produce returns and provide a regular income source.

Read Contra vs Value Fund: Which is better?

How does SWP Work?

A systematic withdrawal plan (SWP) allows you to receive periodic dividends (i.e. Monthly, Yearly, Quarterly) from your investments in your bank account for a period of twelve months.
According to SWP, the following steps are followed:

  • An investor, over time, builds up a corpus of investments.
  • SWPs require the investor to submit desired withdrawal amounts and frequency to the mutual fund house.
  • The mutual fund company redeems its units periodically at the prevailing NAV for the desired withdrawal amount. Investments in balance units continue to be made in the same fund.
  • The investor gets his or her withdrawals transferred to their bank account.

Example: 

If you have 8,000 units in your mutual fund scheme, you would like to withdraw Rs 5,000 monthly through an SWP. We'll assume that the scheme's net asset value is Rs 10. Withdrawing Rs 5,000 from this scheme is equivalent to selling 500 units for Rs 5,000/NAV of Rs 10. In the post-withdrawal state, you will have 7,500 units remaining in your mutual fund (8,000-500).

At the beginning of the next month, if the NAV increases to Rs 20, you will have to sell 250 units to withdraw Rs 5,000, which is the sum of Rs 5,000 and Rs 20. After the withdrawal (7,500-250), there would still be 7,250 units available in the mutual fund. 

As you withdraw funds from a mutual fund, you will lose units. If the NAV of the fund is high, it will be possible to redeem fewer units to meet cash needs.

In contrast, as the NAV declines, even more units will need to be redeemed. If you want to be as effective as possible, plan your SWP while keeping your needs and end goal in mind. A sudden withdrawal can negatively impact the value of your fund.

SWP Calculator | Systematic Withdrawal Plan Calculator With Inflation

Taxation

Taxes are owed on redemptions via SWPs. When capital gains are realized from debt funds, where the holding period is less than 36 months, you are taxed in accordance with your income tax slab rate. Capital gains after indexation that occur after a holding period of 36 months are considered long-term and subject to a 20% tax.

Equity fund investors withholding periods less than one year pay a tax rate of 15% on their capital gains. In contrast, if you have owned a stock for a long time, you pay a tax rate of 10% without indexation.

Investing in an open-ended fund allows for withdrawals or adjustments at any time.

Mutual Fund SWP vs Annuity

An annuity is a financial instrument that pays a fixed amount to an investor on a periodic basis after they retire. Most people use annuities as supplemental income during retirement.

On the other hand, a mutual fund invests in equity, debt, and other financial instruments by pooling resources from a community of investors. Investors are proportionately rewarded for investing in these asset classes.

People who have no experience in the financial markets can invest in equities using a mutual fund scheme managed by a professional fund manager.

The accumulated corpus can be transferred into an accrual debt fund with an SWP once you reach retirement age to accumulate a large amount of wealth for retirement. These regular cash-flows can also provide investors with a regular income after retirement. 

However, if you wonder which one is the right choice, then it largely depends on your financial objectives, investment objectives, and other factors.

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Considerations before opting for SWP

SWP should be considered for several reasons:

Exit Load

Fund exit loads are essential to consider before you make your investment. Try to invest in funds without exit loads.

Tips: You can consider investing in liquid mutual funds and funds with a low duration since exit loads are usually zero. If you choose another fund category, you may want to wait until the exit load period has ended before withdrawing your money. You can invest in liquid funds for one or two years until then.

Pick an appropriate withdrawal date:

The money has to be sent between the first 5 days of each month and the 5th of the following month, so you choose the 31st.

Tips: It's best to pick a date 3-4 days before your cash flow date if payments are delayed due to holidays and other operational problems.

Be cautious before opting for SWP in Equity funds!

You probably know that equity mutual funds and SWPs have many disadvantages if you read blogs.

  • A volatile market can lead to a substantial loss in money value.
  • Markets may move into lower cycles, resulting in lower returns.
  • The exit load for equity mutual funds is typically 1% if you withdraw before one year.
  • Your money can give low returns or cause losses.
  • A volatile market may make you feel uncertain.

Analyze past performance:

You should review the fund's past performance over the last one, three, and five years. Pay attention to the fund manager's performance as well. Did it deviate from its usual course?

Risk Stats:

It's essential to check various parameters, including risk-return ratios and risk statistics.

Hire a Financial Planner: 

To make the right decision, it's always best to seek the advice of a professional.

Disadvantages of Systematic Withdrawal Plans

Some of the disadvantages of SWP are as follows:

  • Averaged Returns: Due to SWP's ability to average costs, it can also average investor returns.

  • Bear markets bring lower returns: Investors must sell more units during bear markets since withdrawal demands are higher, so their returns are lower.

  • Exit Load: SWP may require a load of exit fees from investors if implemented right away.

Conclusion

SWPs offer a steady income stream, making them an excellent option for investors. Further, the rates of return are tax-efficient, and there are no taxes deducted on gains, making them a good choice for investors looking for a fixed income. 

You can invest in this option and get inflation-adjusted returns. SWP is convenient and can help you meet your monthly financial needs. SWP is a technique, but the quality of your investment is largely determined by the fund you choose.

So, before making a decision, you must determine whether the investment fits your portfolio.

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