What is a systematic withdrawal plan and how does it work?



What is a systematic withdrawal plan and how does it work?

Systematic withdrawal plan or SWP is a scheme under which you can withdraw from a lumpsum corpus at a steady rate for an estimated course of your life. It is somewhat similar to SIP, just that instead of investing regularly you withdraw money in a certain pattern(monthly, quarterly, semi-annually or annually). The lumpsum corpus talked about above can either be accumulated with regular investing or be taken from your retirement fund.

 Who can use the SWP scheme?

 SWP facility is useful for people who are about to retire and don't know how much should they withdraw from their retirement money in order to carry in their day to day expenses with ease. It can also be used by people who have some regular expenses and want their unused money to stay invested in high growth funds. However, it is quite obvious that you can't keep on withdrawing Rs.50,000 from a corpus of Rs.20,00,000 for a foreseeable future. Therefore, one needs to invest the right amount to receive a desired monthly cash inflow. 

 Usually, SWP is used by people to withdraw from mutual fund investments, but, an SWP can be created from different investment vehicles such as mutual funds, annuities, brokerage account, individual retirement account, etc.

Why would a person use SWP?

 There are mainly two reasons:

1. A regular cash inflow to meet daily needs and a better return on the unused money so as to beat the inflation as well.
2. The second benefit is lower tax implication i.e. if you are receiving dividends then a dividend distribution tax of 15% is paid by the company, however, in case of long term capital gains in equity mutual funds only 10% tax is imposed.

How does a Systematic Withdrawal Plan work?

 A person either accumulates money by investing money regularly and then after retirement starts a SWP or uses his retirement fund to create a SWP. Let me give an example.

Suppose Mr.X needs Rs.10,000 as a regular income after his retirement and the appreciation rate is 9%. He is retiring next month. Now the question is how much money would he need in a lump sum to achieve his desired goal.

The answer is that he will need Rs.11,48,000 for starting a systematic withdrawal scheme.
Below is a chart showing the cash inflows and outflows.


So, a person can very efficiently manage his expenses by using a SWP. Subsequently, you can use a SWP calculator to even factor in the inflation rate and know how much more lumpsum corpus will be required. In the above case, if the inflation rate is assumed at 5%, a lump sum of Rs.16,55,000 would be required instead of Rs.11,48,000.

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 Thanks for reading!
Please comment on any financial query you had like me to address. I will try to post something worthwhile. 

Coming up Next: Material Pleasure vs. Mental Pleasure. What is the difference between them and which one should you seek?

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