The reverse of a systematic investment plan (SIP) is a systematic withdrawal plan (SWP). The SIP entails regular investment in an equity fund or a debt fund so that you get the maximum benefit of rupee cost averaging. Let us conversely imagine a scenario wherein a retired government official has received a retirement corpus of Rs.10 lakhs. He can invest in an equity fund and withdraw Rs.20,000 every quarter which he requires for his personal expenses. Alternatively he can invest the corpus of Rs.10 lakhs in a debt fund and withdraw Rs.20,000 each quarter. If he wants more safety, he can invest the entire corpus in a bank FD which pays Rs.20,000 as interest each quarter at the rate of 8% interest annually. Let us first look at the equity SWP option. Then we shall compare the debt fund SWP with the bank FD and evaluate the relative merits.
For that we need to understand SWP tax implications vis-à-vis bank FDs. The tax implications on SWP are actually more efficient as we will see later through a live example. The key here is to design a tax efficient systematic withdrawal plan. But first let us, for hypothetical purposes, look at a structure where we design an SWP on an equity fund.

SWP on an equity fund..
Let us assume that to be more efficient, the retiree invests Rs.9,20,000 in an equity fund and Rs. 80,000 in a liquid fund. For the first year, the retiree withdraws Rs.20,000 each quarter from the liquid fund. At the end of the first year, the equity fund becomes long term capital gains and hence regular withdrawals will neither attract capital gains tax nor will it attract any exit loads. But the real challenge arises due to the volatility in equity funds.

Remember, there is no assurance that equities will go up. For example if you invest your money at the peak of the market, as we saw in 2008, your equity corpus could depreciate substantially over the next one year. With negative returns on equities you will end up withdrawing and depleting your principal. That is not a wise thing to do. Additionally, it will be a long term capital loss and you cannot even get a tax credit against that as long term gains on equity is tax free. That is why SWPs are rarely structured on equities. The volatility is the key issue and defeats the entire purpose of regular and assured returns on the corpus.

Quarterly payouts on a bank FD..
Before understanding the tax implications of SWP on a debt fund, let us look at a similarly quarterly payout on a bank FD. Bank FDs typically pay around 8% interest annually. So the deposit of Rs.10 lakhs can be structured so as to yield Rs.20,000 each quarter. What about taxes? The table below captures the tax implications of the bank FD with quarterly payouts..
        
In the table above we can see that the FD interest of Rs.20,000 per quarter gets taxed at the peak rate of 30.9% in the hands of the retiree. So while the retiree does earn Rs.20,000 each quarter and holds the principal value of Rs.10 lakhs, he ends up paying a massive tax of Rs.74,160 in the process over a 3 year period. The question is whether there is a more tax efficient way to structure the SWP? The answer could lie in doing an SWP on a debt fund with very little credit risk.

Tax implications of SWP on debt funds..
A tax efficient systematic withdrawal plan lies at the core of designing a good SWP. If structured as a debt oriented scheme, the SWP tax implications can actually be favourable to the retiree. Here is how; let us understand from the table below..



While debt funds can earn as much as 11-12% annualized returns, for the sake of simplicity and comparison, we assume that the debt fund also gives approximately the same return as the bank FD. Thus the NAV of the debt fund will roughly move in the manner explained in the above table. Instead of getting interest, you regularly redeem units. Since units are redeemed in FIFO format we are assuming that all the gains will be short term in nature for which we are only considering a period of 3 years. Look at the total tax payout. As against a total tax of Rs.74,160 that you will pay in the case of the bank FD over a period of 3 years, in the case of SWP on you will only pay a total tax of Rs.8,804 over a 3 year period. It is this tax advantage that is the big benefit of the SWP structure.

But what about holding principal value?
That is a good question. While the bank FD has paid Rs.20,000/- per quarter the principal of Rs.10 lakhs is still intact. On the other hand, in case of SWP on debt funds you have been withdrawing units from the fund corpus. So what happens to the corpus? Let us also understand that aspect.

In our SWP example, you had purchased 10,000 units of Rs.100 each on the purchase date by investing Rs.10 lakhs. As our SWP redemption table shows, you have redeemed a total of 2115 units. That means you are now left with 7885 units in your debt fund (10,000-2,115). At the closing NAV of Rs.127 your corpus value is Rs.10,01,395/- (127*7885). In other words, your corpus of Rs.10 lakhs is still intact. That is the power of a tax-efficient SWP that is smartly designed!
 

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