STP & SWP23/10/2022 0 By indiafreenotes
STP is a useful tool in mutual funds to average your investment over a specific period. To decide on whether one should do an STP or lump sum depends on three factors an investor’s current allocation to equities, the risk profile of the investor and finally, the market view. For instance, to invest Rs.1 lakh in an equity fund using STP, you may first select either an ultra-short-term fund or a liquid fund.
Features of a Systematic Transfer Plan
Entry & Exit load
To apply for an STP, you need to do at least six capital transfers from one mutual fund to another. While you are free from entry load, SEBI allows fund houses to charge exit load. However, the exit load cannot exceed 2%.
There is no standard minimum investment amount to invest in the source fund. However, some AMCs insist on a minimum amount of Rs.12,000 in their systematic transfer plans.
Taxation on STPs
While an STP is a good strategy, you should be aware of the tax implications and exit loads on the transfer. Every transfer from one fund to another is considered as redemption and new investment. The redemption is usually taxable. The money transferred within the first three years from a debt fund is subject to short-term capital gains tax (STCG). But even with this tax aspect, the returns earned would be higher than those in a bank account.
Disciplined & Lucrative
Systematic Transfer Plan (STP) enables a disciplined and planned transfer of funds between two mutual fund schemes. In most cases, investors initiate an STP from a debt fund to an equity fund.
Investment steps of STP:
First Step: As soon as the lump-sum amount gets credited into bank account, go to websites like moneycontrol or valuereserachonline and pick a good debt based & equity based mutual fund. The units purchased of a debt based fund is the beginning of the process.
Second Step: In the second step you will decide an amount which you would like to withdraw (SWP) each month from the debt fund for onward investing (SIP). This amount can be fixed or variable. We will know more about this in types of STP.
Third Step: The amount decided in 2nd step gets automatically invested (like SIP) to buy units of a pre-decided equity-based fund. In an STP, there is a limitation on number of transfers from a debt fund to equity fund. Example: Minimum of 6 transfers from a debt fund to equity. Read more about other limitations.
Systematic Withdrawal Plan
A Systematic Withdrawal Plan or SWP allows an investor to withdraw from his/her mutual fund scheme every month on predefined dates. This withdrawal could be a fixed or a variable amount. It could be made on an annual, semi-annual, quarterly, or even monthly basis.
Advantages of systematic withdrawal plan
A steady source of income
SWP’s can help your finances by ensuring a steady and regular flow of income as per your chosen period. It can be of great help, especially if you have attained retirement or when you need an extra cash flow to meet expenses like your child’s educational expenses.
Investment with discipline
With SWP, an investor can automatically redeem some mutual fund units every month to meet monthly expenses, irrespective of market levels. Thus, it protects against withdrawing large amounts from panic/fear during volatile market situations. It allows withdrawals even when markets are experiencing new highs and therefore, protects investors from impulsive investment during boom periods.
Since tax is usually payable only on the income component and not the capital component, SWP can be a great way to benefit from tax efficiency. Withdrawals on the SWP are treated as a combination of Capital and Income. SWPs also enjoy tax exemption for up to Rs. 1 lakh on long-term capital gains. The investor needs to pay tax only on earnings in excess of Rs. 1 lakh. In the case of equity funds, tax is to be paid on the gains from equity at 15% on the withdrawn sum if the holding period is less than a year. In the case of debt funds, if it is withdrawn within 3 years, the returns are treated as a part of income and taxed on the basis of the relevant slab rates. On the other hand, if it is withdrawn after 3 years of investment, then the gains from equity mutual funds are taxable at a rate of 20% after indexation, which is, of course, more profitable.
Meeting financial goals
If planned on time, SWPs can be a great asset for you and help you meet your financial goals easily. A second income, besides the salary, is always an added benefit. It can help meet your goals from being delayed due to the unavailability of cash or cash crunch. If set for redemption at a time when you need the most, SWP is a great value addition.