A Systematic Withdrawal Plan () allows investors to withdraw a fixed amount at pre-decided intervals, such as monthly, quarterly or annually, while keeping the remaining corpus invested. However, the tax treatment of SWP depends on the portion of each withdrawal that represents capital gains, as well as the type of .
Let’s take a closer look at how SWP withdrawals are taxed.
Every SWP instalment is treated as a redemption
For tax purposes, each SWP payout is considered a partial redemption of mutual fund units. This means every withdrawal comprises two components, the return of the original investment (principal) and the appreciation earned on those units (capital gains).
The principal portion is not taxable because it represents the investor’s own money being returned. Tax is levied only on the capital gains component of each withdrawal.
The capital gain on each SWP withdrawal is calculated as:
(Number of Units Redeemed × Current NAV) − (Number of Units Redeemed × Purchase NAV)
For example, suppose an investor invests ₹1,00,000 in a mutual fund at an NAV of ₹100, receiving 1,000 units. A few years later, the NAV rises to ₹130 and the investor starts an SWP of ₹13,000.
First SWP: At an NAV of ₹130, the fund redeems 100 units. These units originally cost ₹10,000 but are now worth ₹13,000, resulting in a capital gain of ₹3,000. Tax is payable only on this ₹3,000 gain.
Second SWP: Assume that a month later, the NAV rises to ₹140. To withdraw the same ₹13,000, the fund now redeems only 92.86 units. Since fewer units are redeemed, the original cost is about ₹9,286, resulting in a capital gain of about ₹3,714. Tax is calculated only on this gain.
This shows that the taxable capital gain for each SWP withdrawal can vary depending on the NAV and the number of units redeemed.
Tax treatment depends on the type of mutual fund
The applicable tax on SWP withdrawals varies by fund type.
Equity-oriented funds
For equity-oriented mutual funds, taxation is linked to the holding period of the redeemed units.
If the units are redeemed within 12 months of purchase, the gains are treated as short-term capital gains () and taxed at 20%.
If the redeemed units have been held for more than 12 months, the gains qualify as long-term capital gains (LTCG). These gains are taxed at 12.5% only on the portion exceeding ₹1.25 lakh in a financial year.
Debt funds
Capital gains arising from SWP withdrawals in debt funds are taxed according to the investor’s applicable income tax slab, irrespective of the holding period.
Hybrid funds
The taxation of hybrid mutual funds depends on the fund’s equity allocation.
Hybrid funds with more than 65% exposure to equity are taxed in the same manner as equity mutual funds. Those with equity exposure below this threshold are generally taxed under the debt fund rules.
Other tax aspects investors should keep in mind
Apart from the applicable capital gains tax, there are a few other important points investors should know about taxation on SWP.
- SWP withdrawals are not subject to Tax Deducted at Source (TDS) for resident individuals. As a result, the entire withdrawal amount is credited directly to the investor’s bank account without any tax being cut by the mutual fund house.
- Mutual fund redemptions follow the FIFO (First In, First Out) method, meaning the units bought first are considered sold first. This affects both the holding period and the cost used for calculating gains on each withdrawal.
Disclaimer: This is purely for educational/ informational purposes and should not be taken as any sort of investment advice. Always consult a SEBI-registered advisor before making any investment decisions.