What are STP and SWP in Mutual Funds? A Beginner’s Guide!

Systematic transfer plan (STP) and Systematic withdrawal plan (SWP)

In India, the Mutual Fund industry has started growing off late due to the immense efforts by Association of Mutual Funds in India (AMFI). Previously people used to be more interested in parking their money in Fixed Deposits and Recurring Deposits. Today, many Indians are looking to invest in Mutual Funds for gaining higher returns, ensuring larger security, and enjoying more liquidity.

Unfortunately, the percentage of Indian population investing in the Mutual Funds would not even cross the one-fifth of the total number of income earning Indians. At present, as high as 80% of the Indian income earners are either unaware of Mutual Funds or they have a plethora of misconceptions regarding the same.

One of the myths that many Indians have is that SIP is a feature of the Mutual Fund. The fact is that SIP is a mode of investing in Mutual Funds. You can invest in Mutual Funds either via lump sum mode or through SIPs. Let us have a basic understanding of SIP.

1. Systematic Investment Plan (SIP)

SIP means ‘Systematic Investment Plan’. You can invest a fixed sum of money at specified intervals of time, over a time period in a systematic manner. You can choose to make SIP investments yearly, half-yearly, monthly, weekly, or even daily.

SIPs are similar to Recurring Deposits. You are required to invest your money on a predetermined date and the Mutual Fund Company will provide you units based on that day’s NAV.

If you are looking to invest in the Mutual Funds via SIPs, you do not need to time the market. The major benefit that SIPs provide you is ‘rupee cost averaging.’ Therefore, your investments are not subjected to the risk of market fluctuations as SIP investing averages out the cost of your investments.

Now, there are two crucial concepts associated with SIP. The first one is the Systematic Withdrawal Plan or SWP.

2. Systematic withdrawal plan (SWP)

SWPs allow you in withdrawing a specific amount of money at regular intervals of time. SWP plans are more suited for retired people who are looking for a regular income to meet their expenses, preferably on a monthly basis.

After investing a lump sum amount in a Mutual Fund, the fixed amount and frequency of withdrawal are to be set by you. Not only SWPs help in providing you with periodic income but also protects you from the ups and downs of the stock market.

SWPs work in the manner opposite to SIPs. In case of SIPs, your money is invested in the Mutual Funds from your Bank Account. While, in case of SWPs, your Mutual Funds units are redeemed and gets deposited in your Bank Account.

Let us consider an example to understand how SWPs work in reality. Suppose Mr. Akash is having 10,000 units of a Mutual Fund on 1^st January. He wishes to withdraw Rs 5,000 per month through SWP for the next three months. Therefore he sets up an SWP to give effect to it.

The units from your Mutual Fund holdings will be redeemed automatically to provide you with a regular income of Rs 5000 per month. The table shared below explains the process.

Date	Opening Units	NAV	Units redeemed	Closing units
1st Jan	10000	20	250 (5000/20)	9750
1st Feb	9750	16	312.50 (5000/16)	9437.50
1st March	9437.50	15	333.33 (5000/15)	9104.17

Now let us discuss the second key concept i.e. Systematic Transfer Plan (STP) 

3. Systematic Transfer Plan (STP)

STPs allows you to transfer your money from an Equity Mutual Fund scheme to a Debt scheme. The opposite can also take place. STP acts as protection against market volatility. STP is an automated way of transferring your money from one Mutual Fund scheme to another.

Whenever you feel that the investment made by you in an Equity Fund is being exposed to a higher risk, you can transfer your units to a Debt scheme periodically. Therefore, you can set up STPs which transfers your funds from your Equity scheme to a Debt Fund. When the market settles itself, you can again transfer the money from that Debt Fund to an Equity scheme.

Let us now understand how STPs work. You need to select a Mutual Fund from which your funds should be transferred to another scheme. You can set up STPs in a manner where a transfer can take place. It could be yearly, quarterly, monthly, weekly, or even daily.

STP means redeeming units of a scheme and investing the proceeds in the units of another scheme. Generally, STPs are allowed to an investor by a Mutual Fund company only within the schemes of the same company.

Through setting up STPs, you can keep earning your returns on a consistent basis. Moreover, your investments are also protected against adverse market circumstances. STPs also help you enjoy the benefit of ‘rupee cost averaging’ similar to SIPs.

STPs help you in rebalancing your portfolio. You can keep your funds moving from debts to equity when the Stock Market witnesses a bullish trend. Similarly, you can move your Equity investments away from the market and invest in Debt schemes when the market corrects itself.

Also read:

• 10 Common Mistakes While Investing in Mutual Funds
• The Beginners Guide to Select Right Mutual Funds in 7 Easy Steps.
• 23 Must-Know Mutual fund Terms for Investors.

(Image Credits: Edelweiss)

Taxation rules

Investing via SIPs is not going to fetch you any tax benefit unless you invest in an ELSS scheme. Under section 80C of the Income Tax Act, 1961, you can enjoy a tax deduction on your investments up to Rs 1.5 lakh. This tax benefit is available if you invest in any prescribed securities including ELSS.

SWPs result in the redemption of units of a Mutual Fund. Let us assume that you have invested in a Debt scheme and set up an STP to transfer money to an Equity Fund. Assuming 3 years have not been completed, any capital gain you make due to the redemption of units in Debt Fund will be taxable as per your tax slab. If you withdraw your investments after 3 years, capital gains are taxable @10% and 20%, with indexation and without indexation, respectively.

STPs also result in the transfer of units and therefore the capital gains are subjected to Income Tax. Suppose, you shift your investments from an Equity Fund to Debt scheme within 1 year, the capital gain tax is chargeable @15%. If 1 year exceeds, the tax is attracted @10%, provided capital gains in a Financial Year exceeds Rs 1 lakh.

Also read: Mutual Fund Taxation – How Mutual Fund Returns Are Taxed in India?

Closing Thoughts

If you lack both time and knowledge for Stock Market investing, you can invest your money in the Stock Market via Mutual Funds. For investing in Mutual Funds, you require making use of SIPs, STPs, and SWPs in any phase of your investment journey.

When you earn regular income in our life, investing in Mutual Funds via SIPs seems ideal. As per changing market circumstances, you can set up STPs to maximize your returns by minimizing your corpus loss. SWPs usually come in the picture when you stop earning income actively and looking for a passive source of regular income for the rest of your life.

Mutual Fund is a great investment option for growing your long term wealth. The systematic arrangement of your investments and withdrawals in the form of SIPs, STPs and SWPs help you live a financially disciplined life.