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What are Systematic Transfer Plans and Systematic Withdrawal Plans?

Systematic Transfer Plans (STPs) and Systematic Withdrawal Plans (SWPs) are investment tools available to mutual fund investors to help them invest more systematically, effectively and strategically.

About Systematic Transfer Plans (STPs)

You can use a Systematic Transfer Plan (STP) to invest a lump sum amount in one scheme and periodically (monthly, quarterly, etc.) transfer a pre-defined amount from that scheme into another scheme on a pre-specified date. A smart choice for those investors who wish to manage risk over the long term, STPs work especially well during times of volatility as they allow you the advantage of systematic, automated and periodic transfers without the need for any additional action.

Effective use of a STP

Under STP, a lump sum amount can be invested in a debt fund and periodic transfers are made into an equity fund as a protection against immediate stock market volatility and slow exposure to a slightly more risky asset class. This will ensure regular transfers to the equity fund while the corpus in the debt fund keeps accumulating returns. The benefit of STP is clear from the example below:

2 TABLES WILL COME HERE

As you can see from the above table, the investor has moved a fixed amount every month i.e. Rs. 5,000 from a debt fund into an equity fund. While he continues to earn returns in the debt fund, he is also benefiting from gains accruing in the equity fund. Now even if the investor were to make a marginal loss in the equity fund, his debt investment would still have covered partly or fully for such a loss. As against this strategy, had the investor invested the lump sum directly into an equity fund at the start of his investment plan, he could have experienced erosion in his capital due to market volatility. Thus a STP can actually be a superior strategy than lump sum investing in equity and is a great hedge against market volatility.

A point to note:
Investors can choose to transfer a fixed sum periodically using a STP or just the capital appreciation from one fund to another.

Using STP for one’s retirement needs

A person approaching retirement can use STP in a reverse manner, that is, transfer a pre-determined amount periodically from an equity fund into a debt fund. This serves two purposes – it helps fund one’s retirement needs and helps reduce the risk associated with equity investment as one nears retirement.

Are there different kinds of STPs?

Yes, today many mutual fund houses have started offering different ways of starting an STP, which are flexible and respond to different market situations automatically. Some may have a feature that allows your monthly transfer amounts to increase automatically if the market falls and others may have the feature to allow your transfer amounts to increase or decrease based on market movements while also readjusting the overall transferred amount to limit asset class exposure over a desired level.

How are STPs taxed?

A STP transaction is treated like redemption from the fund you are transferring amounts from (also called the source fund), and a fresh investment into the fund you are investing in (also called destination fund) for tax purposes. If the source is a debt fund, then short term capital gain taxes will apply in case the transfers are made within 3 years of initial investment. You will be taxed according to the income tax slabs applicable to you. If the transfers are made after 3 years of investment, the gains will be taxed at 20 per cent after taking indexation benefit. Capital gains earned on redemption from the destination fund, which will be the equity fund, will be taxed at the rate of 10% for capital gains exceeding Rs 1 lakh for a financial year; however, if this is done before 12 months, tax at 15% will be payable on the gains.

About Systematic Withdrawal Plans (SWPs)

A Systematic Withdrawal Plan (SWP) is a tool that allows you to withdraw a fixed amount of money at pre-specified intervals. The money you withdraw can be held by you in cash or reinvested. SWPs are a smart choice for those investors who wish to invest today to earn capital appreciation on their saved up money but also seek a periodic income over the long term.

Effective use of a SWP

You can use a SWP to generate regular income; this is especially for those who are looking to plan for their retirement years, or fund some other activity that requires a fixed amount of money at regular intervals. SWPs make sense because:

  • You get an income irrespective of gains or losses on your investments. This is called fixed withdrawal.
  • You have the option to set up a SWP in such a way that only gains on investment are withdrawn regularly. This is called appreciation withdrawal.

As an example, let’s consider an investor who wants an income of Rs. 10,000 per month. At the current NAV of Rs.107, he has 2,000 units of an equity mutual fund:

TABLE COMES HERE

In the above example, the investor is taking regular income from his mutual fund, and irrespective of market movement, he is able to keep withdrawing a fixed amount of money.

How are SWPs taxed?

A SWP is nothing but redemption of units from the scheme; the tax treatment of each withdrawal will be the same as in the case of redemption of equity or debt funds. There will be short term capital gains tax on equity holdings of less than 12 months and debt holdings of less than 3 years, and long term capital gains tax on longer periods for debt funds (long term capital gains on equity funds are taxed at the rate of 10% for capital gains exceeding Rs 1 lakh for a financial year).

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Key Takeaways

  1. STPs help you benefit from market volatility when done from a debt fund to an equity fund.
  2. SWPs help you generate liquidity, which can be especially useful for your sustenance needs during retirement or for a specific purpose that needs cash at regular intervals.
  3. You should consider capital gains taxation before choosing to start a STP or SWP.