A Systematic Withdrawal Plan (SWP) is a great option for investors who want to regularly withdraw money from their mutual fund investments. While SWPs provide a reliable income stream, understanding the tax treatment of withdrawals is crucial to avoid surprises. In this blog, we’ll break down how SWPs are taxed and what you need to know before making withdrawals from your mutual fund investments.

What is a Systematic Withdrawal Plan (SWP)?

Before we dive into the tax treatment, let’s first understand what an SWP is. A Systematic Withdrawal Plan (SWP) allows you to withdraw a fixed amount from your mutual fund investment at regular intervals, such as monthly or quarterly. It’s a good option for investors who are looking for a steady income without the need to sell their investments all at once. You can choose to withdraw from equity mutual funds, debt funds, or hybrid funds, depending on your financial needs.

Tax Treatment of SWP

The tax treatment of SWP is an essential aspect for every investor to understand. SWPs are not tax-free, and the tax depends on the type of mutual fund you are invested in and the duration for which you hold the investment. Let’s break it down:

1. Tax on Equity Mutual Funds

Equity mutual funds are those that primarily invest in stocks. The tax treatment on SWP withdrawals from equity mutual funds depends on how long you have held the investment:

• Short-Term Capital Gains (STCG): If you redeem or withdraw units within 1 year of investment, the gains are classified as short-term capital gains. These are taxed at 15% (plus applicable cess).
• Long-Term Capital Gains (LTCG): If you redeem or withdraw units after holding them for more than 1 year, the gains are classified as long-term capital gains. LTCG up to ₹1 lakh in a financial year is tax-free. Gains above ₹1 lakh are taxed at 10% (without the benefit of indexation).

2. Tax on Debt Mutual Funds

Debt mutual funds invest in fixed-income securities such as bonds and government securities. The tax on SWP withdrawals from debt mutual funds is as follows:

• Short-Term Capital Gains (STCG): If you redeem or withdraw units within 3 years of investment, the gains are classified as short-term capital gains. These are taxed at 20% with indexation benefits.
• Long-Term Capital Gains (LTCG): If you redeem or withdraw units after holding them for more than 3 years, the gains are classified as long-term capital gains. LTCG is taxed at 20% with indexation benefits.

3. Tax on Hybrid Mutual Funds

Hybrid mutual funds invest in both equities and debt. The tax treatment depends on the proportion of equity and debt in the fund:

• If the equity component is more than 65%, it is treated like an equity mutual fund for tax purposes.
• If the equity component is less than 65%, it is treated like a debt mutual fund for tax purposes.

How is Tax Calculated on SWP Withdrawals?

When you make withdrawals under an SWP, the tax is calculated on the capital gains you make from the withdrawal. The capital gains are the difference between the selling price and the purchase price of the units. The tax you pay depends on how long you held the units before withdrawing them. Here’s an example:

Let’s say you invested ₹1,00,000 in an equity mutual fund, and after 1 year, your investment has grown to ₹1,20,000. If you decide to withdraw ₹10,000, your capital gain will be ₹2,000 (₹10,000 * 20% of ₹1,00,000 = ₹2,000). If your total LTCG for the year exceeds ₹1 lakh, the tax on this gain will be 10% (₹200). If your total LTCG is below ₹1 lakh, there is no tax on it.

What to Remember When Withdrawing via SWP?

• Keep track of the holding period of your investments to determine whether your gains are short-term or long-term.
• If you're withdrawing from both equity and debt mutual funds, be mindful of the different tax treatments for each type.
• Remember that taxes are deducted only on the capital gains portion of your SWP withdrawal, not the principal invested.
• Ensure you file your taxes properly to include the gains from your SWP withdrawals.