Early bird gets the pension

After setting aside money for different goals such as children's education, their marriage and so on, the most important thing you should consider is planning and investing for your retirement and pension. Doing this early in your career will ensure a higher sum at retirement.

Given that there is no social security system in India as in western countries, investing in pension plans is the key to a financially secure retired life.

Here we detail the key avenues where you can invest for your retirement and look at aspects such as returns, tax issues, cost structure and liquidity while evaluating individual products. We discuss the pension plans of life insurance companies, the NPS (New pension scheme), mutual fund retirement funds and the more common PPF and EPF schemes.

Insurance pension plans

Life insurance companies, led by state behemoth LIC, and private players such as HDFC Life, Birla Sun Life, Bajaj Allianz and Aviva offer what are commonly called annuity products. These are also called unit linked pension products or ULPPs .

Broadly, there are two types of ULPPs — single premium and regular premium annuities. A single premium policy is one where you pay a lump sum that you may have accumulated over the years and purchase an immediate annuity (a stream of monthly income over several years). For this, most insurance companies set a minimum 40-year age limit. This means that you pay a lump sum this month and start receiving a pension from the very next. The other more long-term oriented scheme is the regular premium policy.

Briefly, this means that you pay a regular premium — monthly, quarterly or annually — over a period of 10-25 years depending on your chosen retirement date or pension vesting date. Insurance companies give many options to choose from, allowing varied proportions of debt and equity investments ranging from 100 to 20 per cent.

In case you ask for a basic sum assured, irrespective of the fund value, the insurance company will also specify the premium that you will need to pay.

Please note, though, that charges are relatively higher for ULPPs, especially in the initial years.

Charges : The premium allocation charge in the first year can be 6.75-7.5 per cent of your premiums in the first year and around 4-5 per cent till the fifth year. After the fifth year, the charges are in the 2.5-3.5 per cent range across insurance companies.

Apart from these, you will have policy administration charges of Rs 30-50 per month and fund management charges of 0.7-2 per cent. The point is, it is prohibitive to surrender or discontinue your policy within the first five years and you must typically stay invested at least for 10-15 years.

Returns : In terms of returns generated, it may be noted that ULPPs have delivered 6-13 per cent compounded returns over the past five years. Their three-year track record is better, with some schemes delivering as high as 33 per cent annual returns. What is more, some of these schemes have only 20-40 per cent invested in equity, making for a lower risk profile than balanced mutual funds.

At the end of the accumulation phase, when you purchase the annuity, the rates at which you purchase the annuity is decided based on the 10-year government securities yield prevalent at that time.

Tax : At the end of your vesting period, you have the option of taking one-third of your accumulated corpus as a tax-free amount. With the balance two-thirds, you need to buy an annuity scheme from the insurance company that would pay you a regular pension. Alternately, you can use your entire accumulated corpus for buying an annuity.

Taxation may be an issue, going forward, though. Until now, premiums paid towards pension plans were allowed to be deducted under section 80 C, for computation of tax. So if you were in the 30 per cent tax bracket, you could have saved up to Rs 30,000 in outflows.

The proposed new tax code, as it stands now, does not mention premiums paid to ULPPs for tax deduction purposes. Pending clarity on this issue and the possibility of a tighter charges regime imposed on insurance companies, you must consider investments in these products and choose a scheme that suits your risk profile — pure equity or hybrid equity. You have the option to switch to debt based schemes closer to your vesting date so that your accumulated corpus is preserved.

There is a high probability that betting on equity, you would make money, especially over such long-time frames as 15-25 years.

PPF and EPF

By far, the simplest of retirement products are the public provident fund (PPF) and the employee provident fund, EPF. A PPF account can be opened with post offices or select national banks such as SBI. It has a 15-year lock-in, with an option to increase it by two blocks of five years each, which effectively means a 25-year horizon. Recently, the ceiling for annual investment in this product has been raised from Rs 70,000 to Rs 1 lakh.

The interest rate has also been increased from 8 per cent to 8.6 per cent.

But if you can invest Rs 8,333 every month for a period of 15 years, you will end up with Rs 30 lakh and if you choose to continue for a further 10 years, you would accumulate as much as Rs 88 lakh. You can also open accounts in the name of your spouse as well as children.

Tax : The clincher as far as investments in PPF are concerned is that it allows you deduction for tax purposes, the interest accumulated as well as the final amount, all are exempt from any tax. So if you add up any investments made in the name of your spouse or children, it could make a sizable corpus.

The EPF or the employee provident fund is the default retirement product for most, given that monthly deductions are made from the salary earned. Right now, 12 per cent of your basic pay goes to the EPF kitty, with your employer contributing an equal sum. Here again, the rates keep varying — the rate in recent years has been 8.5 per cent with the last couple of years seeing 9 per cent rate of interest.

If, currently, your basic pay is Rs 10,000, you will be able to accumulate as much as Rs 59 lakh in 30 years' time, even if your salary grows by 5 per cent annually.

So, by a combination of PPF and EPF itself, you can accumulate over Rs 1 crore quite comfortably. It is another point altogether as to whether that would be enough for a retired life 30 years from now. It must be noted, however, that the rates in EPF and PPF can be reset periodically by the government, even downwards, if necessary.

There is a perception that the yields in government securities with 10-year maturities may have peaked at current levels and if the interest rate cycle starts to go down, rates on these schemes too may be set lower.

Despite these facts, PPF and EPF must form a key part of your retirement kitty, given the tax incentives as well as near risk-free profile.

For any shortfall, you must look to invest largely in ULPPs or the NPS so that you get market linked returns.

Retirement Mutual funds

UTI Retirement Benefit Pension Fund and Templeton India Pension Plan are the two specialised retirement funds that have been in existence for over a decade. More recently Tata Mutual too has launched a retirement savings plan.

These are funds that invest a major (around 60 per cent) portion of their portfolio in debt instruments and the rest in equity. Investors basically contribute sums periodically like a regular SIP and after the age of 58 or 60 years, it is converted into an annuity with an assured pension with the corpus accumulated.

While the UTI and Templeton funds enjoy tax benefits under section 80 C, Tata Mutual's scheme doesn't. However, with changes likely in the DTC, the tax exemption even for UTI and Templeton isn't a certainty. More importantly, both these funds have lagged their benchmark as well as category average over five-year timeframes.

Investors seeking mutual fund options may find plain vanilla open ended balanced funds a better option. Investors should, however, exercise the discipline to stay invested for 5-10 years to reap the best rewards.

Funds such as HDFC Prudence, HDFC Balanced, Birla Sun Life '95 and DSPBR Balanced may fit your bill, given their long track record of delivering superior returns. These funds have delivered compounded annual returns of 21-26 per cent over a 10-year time frame.

A simple product, but...

The NPS is a relatively simple product, which is similar to a mutual fund. There are six pension fund managers currently — ICICI Prudential, IDFC, Kotak Mahindra, Reliance, SBI and UTI. Since it was launched a little over two years ago, there isn't a substantial track record to go by.

Investors must make a minimum of Rs 6,000 contribution in a year and at least Rs 500 per month. There is no upper ceiling on investments.

There are three schemes — E or the equity instruments, C or fixed-income products or bonds and G or government securities. You can choose the proportion of allocation of your monthly instalments in these three categories. The investment in equity can only be to the tune of 50 per cent of your monthly payout.

There is also an auto option wherein, based on your age, the asset allocation progressively tilts to government securities from a high equity portion in your early years.

The key drawback in this scheme is that investments only in index funds tracking the Sensex or the Nifty are allowed, in the equity portion. This can limit returns vis-à-vis active picking of stocks. After your investing period or when you turn 60, you must buy an annuity from an IRDA approved insurance company.

Charges : There is an account opening charge of Rs 50 and another Rs 40 is charged for initial subscriber registration by the PoP (point of presence).

Apart from this, the annual maintenance charges are Rs 280 currently. The charge per transaction is Rs 6. The PoP is also paid Rs 20 per transaction.

To put all this in perspective, if you contribute Rs 1,000 per month, your annual charges could work out to 4.3 per cent.

Of course, if your monthly instalments increase substantially, the charges would be much lower.

Tax : Your instalments are allowed as deductions under section 80 C. After the contributing phase is over, you can withdraw up to 60 per cent of the accumulated corpus as a lump sum, after you turn 60. But the caveat is, at present, this lump sum is taxed.

However, under the DTC regime, this clause may be revoked and the lump sum could end up being tax-free. For the balance 40 per cent, you are required to buy an annuity.

These funds may have to be tracked over longer timeframes to check if they have outperformed markets before one takes the plunge, given that they have a rather restrictive equity mandate.

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