Whenever I ask people about retirement planning, they think that I am talking about a distant future which will be taken care of automatically. (I don’t blame them as it is psychologically difficult for people to take such a long term view of things).And when I show them how ill prepared they are for their retirement based on their current savings rate and investment returns, they get a rude shock!
Many people think that their income/expense levels will remain the same post retirement. Most of people working in the private sector won’t have the luxury of a pension in their retirement years. So it is our responsibility to build a retirement corpus that will last us for our life.
In India, most of the people start to work between 22-25 and retire by 60- a working life of about 35 to 40 years. With average age expected to climb up to 80-85 years in the coming times, one needs to be able to live of your retirement income for atleast 25-30 years. Have you really estimated your expenses and income during that time? Have you estimated your medical expenses?
I find people planning a lot for their kid’s education or their child’s marriage but never think or plan about their own retirement needs. Without any planning, you might have really difficult times meeting your expenses in your old age.
In the coming times, financial planning will not be a luxury but a necessity.
Recently there was a lot of hue and cry when Govt cut the PPF rates to 8.1%. Also long term FD rates are coming down drastically in the system. Currently 5 years FDs are fetching about 7.5%( might go even lower after RBI rate cuts in April). Now this is bad news for the savers and those who take unrealistic assumptions for PPF/EPF returns in their retirement planning.
So what is the way forward for interest rates?
If we look at the global interest rates, India still has one of the highest interest rates in the world. See this table and you will realize that Indian interest rates are bound to come down as 70-80% of world economies are having interest rates less than 3-4%. US is at 0.5% and while Japan and EURO area are having negative interest rates ! Indian interest rates as set by RBI is currently 6.75%. This is with inflation currently around 5.1%. With the formation of new MPC, RBI Gov. Rajan has been given the mandate to keep the inflation between a band of 2-6%. Considering that, 7-8% should be peak for interest rates in the economic. And if Global deflation continues, we might see even lower rates(as low as as 3-4%) in the economy.
While lower interest rates are good for the industry and the economy, for savers and retirees it is bad news. Imagine how savers are managing in developed economies where interest rates are zero or below zero!
This also implies that you can’t afford to be all 100% in debt, you will have to assume some risk and get into equities. Although it is very difficult to say that you will be adequately compensated for taking that risk in equities. Even equity returns would fall from 15-17% CAGR to about 10-12% CAGR(or even lower) for longer periods of time.
So when you are planning for your retirement 20-30 years down the line, keep in mind such return assumptions. Don’t assume lofty returns of 10-15% on your portfolio!In the short term(say 1-2 years), equities might zoom because of global liquidity so it might make sense to be slightly overweight on this asset class. But if global growth doesn’t pick up in next 1-2 years, it will be very difficult to get returns from any asset class except Gold as people will just turn to Gold for security. Hence, it is always prudent to keep at least 10% of your portfolio in Gold.
Best Pension Plans in India
Retirement is a phase to enjoy freedom from work, engage in leisurely activities, pursue hobbies, embark on travel expeditions and basically do everything that you wanted to do but couldn’t because of your active working years. But, to live a king-size life during your golden days, you need to start your retirement planning as early as possible. According to The Aegon Retirement Readiness Survey 2015, Indian workers expect that they will need an average of 58% of their current income in retirement. However, they also believe that they are on track to achieve only 71% of the retirement income they need. Do you think you are on right track to financial planning for retirement?
What you should focus is on creating a sound, well-balanced investment portfolio to meet your retirement goals. There are several investment products such as fixed deposits, stocks, mutual funds, life insurance, real estate, commodities and precious metals, among a few others available in India. However, pension plans are recently gaining popularity as they are specifically targeted to meet retirement goals. So, it makes a wise decision to allocate a certain portion of your investment towards pension plans.
What are Pension or Retirement Plans?
Pension plans are a type of investment product that encourages you to create a retirement account. That is, you can build a huge corpus over a period of time in order to receive a fixed payout when you retire.
The pension plans broadly cover two phases:
- Accumulation: During this phase, you focus on making investment to accumulate the funds you need post retirement. This is the period between your current age and retirement age.
- Distribution: During this phase, you start withdrawing an amount to fetch a regular income from your retirement corpus. This period begins from your retirement age.
If a pension plan is taken from an insurance company (discussed below), you are entitled to an annuity. Annuities refer to the stream of income an insurer pays at regular intervals to the investor until his death or at the end of tenure he may have opted for. The corpus at the end of the accumulation phase will be paid out in two parts – 1/3rd in the form of lump sum, with the remaining will be converted into annuities.
Let’s take an example of how annuity works. Shirish is a 35 year old IT professional who wants to retire at the age of 65. He invests Rs1 lakh per annum in a pension plan for a period of 30 years. The total premium he pays over 30 years is Rs30 lakhs. Assuming that his investment grows @8% per annum, his corpus will accumulate to around Rs93 lakhs by the time he retires. So, he can withdraw Rs31 lakhs as lump sum amount upon retirement and receive a pension of around 6 lakhs per annum as pension (annuity) from the balance 2/3rd amount for the rest of his life.
The annuity based pension plans can be classified into two categories:
- Deferred Annuity: Here, you invest a fixed amount till your retirement age. The withdrawal or benefits will commence only upon attaining the retirement age.
- Immediate Annuity: Here, you invest a lump sum amount to commence annuity with immediate effect. Ideally, this is suited for those who are nearing the retirement age or prefer lump sum investment.
Types of Pension Plans
Surprisingly, for a country like India, where elderly population aged 60 years and above is expected to rise from 77 million in 2001 to 179 million in 2031 and further to 301 million in 2051, there aren’t still many pension schemes available. In fact, only 12% of India’s workforce is covered under government administered pension schemes.
Currently, there are following pension plans available in India.
- National Pension Scheme (NPS)
- Traditional Retirement Plan
- Unit Linked Pension Plan (ULPP)
- Mutual Fund Linked Retirement Plan (MFLRP)
- Employee Pension Scheme (EPS)
We will discuss each of the above pension plans in detail.
National Pension Scheme (NPS)
NPS was launched in April 2004 by the government of India and regulated by Pension Fund Regulatory and Development Authority (PFRDA) to meet the following objectives:
- To help people plan their retirement income
- To encourage the habit of savings
- To bring pension reforms
Who are eligible for NPS?
- Central government employees
- State government employees
- Employees of corporate entities
- Individuals between the age group 18 to 60 years
- Employees of unorganized sector
The NPS subscriber gets a unique Permanent Retirement Account Number (PRAN), through which the minimum amount of Rs6000/- can be invested annually in the following accounts:
- Tier I Account: The amount can be withdrawn only after the retirement age – there is a lock-in period till the age of 60. After that, 60% lump sum upon attaining the age of 60 and the balance 40% in the form of annuity.
The investment in Tier 1 account can be claimed for deduction up to Rs1.50 lakh, along with other investments that fall under Section 80C. However, the interest accrued on the total investment and the amount used by the subscriber to buy the annuity is taxable.
- Tier II Account: The subscriber can withdraw funds periodically from Tier II account. However, there are no tax deductions available.
There are 3 fund schemes available under NPS.
- Scheme E, where 50% of investment is put in equity.
- Scheme C, where investment is made in fixed income instruments other than government securities.
- Scheme G, where investment can be made in government securities.
In spite of its long lock-in period, NPS is gradually climbing the popularity chart of pension products due to its low cost (maximum 0.25%) and healthy returns (see the chart below) features.
Visit www.india.gov.in/spotlight/national-pension-system-retirement-plan-all to know more about NPS.
Traditional Retirement Plan
Traditional retirement plans are offered by insurance companies. Under these plans, the insurance companies usually invest the amount in government bonds or securities grades with a high credit rating. However, the investment portfolio and costs are not disclosed to the investor. The investors get a minimum guaranteed return here. They may also get additional returns in the form of bonuses, depending on how well the fund has performed. There is a death benefit too, since these plans are primarily insurance plans.
Traditional retirement plans are a good option for conservative investors who have a short-term horizon or look for safe risk-return trade-off. However, these plans offer very low returns (around 5 – 7%) and do not even meet the service tax and inflation costs. Further, withdrawals are not allowed before maturity.
Both types of annuity options – deferred and immediate are available under these plans. Currently, most insurance companies offer traditional retirement plans. For example, LIC Jeevan Akshay VI, ICICI Prudential Forever Life and HDFC Life Personal Pension Plan are deferred annuity plans. While, LIC New Jeevan Vidhi, ICICI Prudential Immediate Annuity and HDFC Life New Immediate Annuity are immediate annuity plans.
These plans are eligible for tax benefits under Section 80C on the premium paid up to Rs1.50 lakhs. The lump sum amount withdrawn on maturity or death is non taxable while the annuity amount is considered as taxable income.
Unit Linked Pension Plan (ULPP)
The basic structure of ULPPs is similar to Unit Linked Insurance Plans (ULIPs) – the investment amount (premium) is invested in equity after deducting certain expenses and charges. The investors have complete transparency how their plan is being managed. There is a lock-in period of 5 years. Depending on the market performance of funds, the corpus accumulates over a period of time. The investor gets life cover also as there is an insurance component attached to the ULPPs.
ULPPs an advantage over traditional retirement plans as it allows the investors to participate in the equity, based on their risk appetite and investment goals. The investors can switch between equity-debt funds to earn better returns.
If you survive the tenure of the plan, you get a guaranteed maturity benefit equivalent to 101% of the premiums paid or the fund value, whichever is higher. 1/3 of the corpus is paid in the lump sum. With the balance amount, you require to purchase an annuity which can start immediately. There is also an option to use the entire corpus to buy a single premium deferred pension product.
The amount invested in ULPP is deductible under Section 80C up to Rs1.50 lakhs annually. The lump sum amount (1/3rd of corpus) received on maturity is tax free. However, the annuity taken from the remaining 2/3 amount is taxable.
Let’s take an example how a ULPP works. Amit is a 35 year old married male. He decides to invest Rs1,00,000 every year towards ICICI Pru Easy Retirement Plan to retire at the age of 65 years. His asset allocation is balanced fund, in which up to 50% investments will be in equity and equity related securities. The rest will be invested in Debt,
Money Market & Cash instruments. Now, upon attaining retirement age, he is entitled to a corpus of around 1.95 crores, assuming the returns on the investment were @ 8%. After withdrawing 1/3 of the total corpus at the time of maturity of the plan, he can choose to receive pension from the balance amount for the remaining years of his life.
Mutual Fund Linked Retirement Plan (MFLRP)
Interestingly, you can also buy pension plans from mutual fund companies in India. Till 2014, pension plans from only two fund houses – Templeton Pension India from Franklin Templeton and Retirement Benefit Pension Unit Trust of India (UTI) were available. However, after Finance Ministry and Securities Exchange Board of India (SEBI) approved new MFLRPs, Reliance launched its first MFLRP known as Reliance Retirement Fund. Other fund houses like like HDFC, Axis, Reliance, SBI and others are still waiting for approval, but they will in the markets soon.
MFLRPs allow the investors to maintain an aggressive portfolio while accumulating corpus for their retirement years. They can invest in equity, equity-related instruments, debt and money market instruments, among others. The investors can also choose the asset class and equity – debt ratio of the portfolio as per the age or risk – appetite. Higher equity exposure at a young age and lower as the person nears the retirement age. Further, unlike traditional and unit – linked retirement plans, it is not mandatory to buy an annuity in MFLRP. They primarily concentrate on the accumulation phase of a pension plan. The investor can withdraw 100% of amount at the time of the retirement age.
The lock-in period varies from one MFLRP to another. However, premature withdrawals are penalized in the form of heavy exit load charges. Also, since these pension plans are market-linked, there is no assurance or guarantee of returns.
Currently, investment in MFLRPs up to a limit of Rs.1.50 lakhs is eligible for a deduction under section 80C. The lump sum amount withdrawn on maturity or death is non taxable while the annuity amount is considered as taxable income.
Which Pension Plan is Better?
It actually depends on your retirement goals and various factors like age, risk profile and personal circumstances. Pension plans are long – term products with an aim to create wealth for retirement. Hence, the flexibility of premature withdrawals is low. If you are in the age group 25 – 45, you can afford to be an aggressive investor by diversifying your funds into a higher percentage of equity in ULPP, MFLRP or NPS. If you are nearing retirement or a late investor, you may go for traditional retirement plans or else switch to debt-oriented funds in ULPP, MFLRP or NPS.
A comparative chart between all pension plans should help you to take the right decision.