How Does SWP Work — Which Units Are Sold Each Month?

How a Systematic Withdrawal Plan (SWP) Really Works

Imagine you have carefully built a mutual fund portfolio over many years. Now, you need a regular income from it. A Systematic Withdrawal Plan (SWP) helps you do just that. When you use an SWP, your mutual fund house sells units based on a ‘First-In, First-Out’ (FIFO) basis. This means the oldest units you bought are sold first to generate your monthly cash flow. Many people ask, 'what is SIP in mutual fund?' and think of it as just investing. An SWP is the opposite; it’s about creating an income from those investments.

Think of it like a planned harvest from a tree you've grown for years. You don't chop the whole tree down. You just pluck the fruits you need, letting the tree continue to grow. An SWP works similarly, allowing your core investment to potentially keep growing while you draw a steady income from it.

What Exactly is a Systematic Withdrawal Plan?

A Systematic Withdrawal Plan, or SWP, is a facility offered by mutual funds. It allows you to withdraw a fixed amount of money from your mutual fund scheme at regular intervals. These intervals can be monthly, quarterly, or even yearly.

You decide the amount and the frequency. For example, you could instruct your fund house to pay you 10,000 rupees on the 5th of every month. The fund house will then sell just enough units from your holdings to cover that 10,000 rupees and transfer the money to your bank account. This is very different from a lump-sum withdrawal, where you sell all your units at once. With an SWP, the rest of your money remains invested in the market, giving it a chance to grow.

This method is popular among retirees who need a regular pension-like income. It is also useful for anyone who needs a predictable cash flow to cover regular expenses, like paying a child’s school fees or a home loan EMI.

FIFO Explained: Which Units Get Sold First?

The most common question people have about SWPs is: how does the fund decide which units to sell? The answer is the First-In, First-Out (FIFO) method. It’s a simple rule: the units you purchased first are the ones that are sold first.

This method is important for calculating taxes, specifically capital gains tax. Since the oldest units are sold first, they are more likely to have been held for a longer period. This often means they qualify for long-term capital gains tax, which can be more favorable than short-term capital gains tax.

Example of FIFO in Action
Let's say you invested in an equity mutual fund over three months:

• January: You bought 200 units at a NAV of 50 rupees per unit.
• February: You bought 200 units at a NAV of 52 rupees per unit.
• March: You bought 200 units at a NAV of 55 rupees per unit.

Now you have a total of 600 units. You decide to start an SWP and withdraw 5,000 rupees per month. When your first withdrawal happens, the fund house needs to sell units to generate 5,000 rupees. Let’s assume the NAV on the withdrawal date is 58 rupees.

The fund will calculate the number of units to sell: 5,000 rupees / 58 rupees per unit = 86.20 units.

Because of the FIFO rule, these 86.20 units will be sold from your January purchase. After the withdrawal, you will have 113.80 units left from your January purchase and all 400 units from your February and March purchases.

How Does an SWP Work? A Step-by-Step Process

Setting up an SWP is a straightforward process. Here’s how it works:

1. Build Your Investment Corpus: First, you need money in a mutual fund. You might have invested a lump sum or built up a corpus over time using a Systematic Investment Plan (SIP).
2. Choose Your Withdrawal Details: You need to decide how much money you want to withdraw and how often. You can choose a fixed amount (e.g., 20,000 rupees) or a fixed number of units to sell each time. You also select the frequency: monthly, quarterly, etc.
3. Submit the SWP Form: You fill out an SWP registration form with your mutual fund house. This can usually be done online or by submitting a physical form. You will need to specify the scheme, withdrawal amount, frequency, and the date you want the withdrawal to happen.
4. Units are Redeemed: On the chosen date, the Asset Management Company (AMC) sells units from your holdings. They use the FIFO method to determine which units to sell. The number of units sold depends on the Net Asset Value (NAV) of the scheme on that day.
5. Money is Transferred: The proceeds from the sale are transferred directly to your registered bank account. This process repeats automatically according to the schedule you set.

Understanding SWP vs. What is SIP in a Mutual Fund

People often get confused between a Systematic Investment Plan (SIP) and a Systematic Withdrawal Plan (SWP). They are two sides of the same coin: one is for building wealth, and the other is for using it.

A SIP is a method of investing a fixed amount of money in a mutual fund scheme at regular intervals. This is the accumulation phase. You are buying units regularly to build a large investment portfolio over time. It helps you invest in a disciplined manner and benefits from rupee cost averaging.

An SWP is the reverse. It is a method of withdrawing a fixed amount of money from your mutual fund investment at regular intervals. This is the distribution phase. You are selling units regularly to create a steady income stream. For more official information on mutual funds, you can visit the Association of Mutual Funds in India website at AMFI India.

Here is a simple comparison:

Pros and Cons of Using an SWP

Benefits of an SWP

• Regular Income: It provides a predictable cash flow, which is great for managing monthly expenses, especially in retirement.
• Market Participation: Your remaining capital stays invested, which means it has the potential to grow over time and possibly beat inflation.
• Tax Efficiency: The FIFO method often leads to long-term capital gains, which are typically taxed at a lower rate than short-term gains.
• Flexibility: You can stop, start, or change the SWP amount as your needs change.

Drawbacks to Consider

• Market Risk: If the market is down, the fund house will have to sell more units to generate your fixed income amount. This can deplete your capital faster than expected.
• Capital Erosion: If your withdrawal rate is higher than your investment's growth rate, you will eventually run out of money. It is crucial to choose a sustainable withdrawal rate.

An SWP is a powerful tool for financial planning. By understanding that it sells your oldest units first, you can better plan your income stream and manage your taxes effectively. It transforms your accumulated wealth into a source of regular, reliable income.