Portfolio

How to retire rich and happy

K Venkatasubramanian | Updated on January 24, 2018

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With so many pension products, it’s hard to decide. Here, we help you make a choice

It would be difficult to believe that Indian investors have a tough time building a retirement kitty. After all, look at the extensive menu of products available to them — from the cast-iron Employees Provident Fund (EPF) and Public Provident Fund (PPF) to market-linked pension plans of insurers and the ultra-low-cost National Pension Scheme (NPS). Now, mutual funds too are throwing their hat into the ring and offering retirement plans.

Reliance Mutual Fund has already launched a retirement fund and products from SBI and Axis Mutual Fund are waiting in the wings.

But while the array of retirement products available to retail investors is quite extensive, choosing between them is far from easy.

Products that offer healthy returns aren’t easy to operate and come with strings attached. The ones that offer safety barely manage to beat inflation. And some plans are heavily marketed but score badly both on costs and returns.

Apart from costs and returns, the manner of withdrawal of proceeds at the time of retirement and taxation too are key aspects to be looked into, while selecting a good retirement plan. To make things a little easier for investors, here’s an analysis of each of these products, and who should opt for them.

EPF and PPF

The Employees Provident Fund is often the default option for most salaried people looking to build a retirement corpus.

Contributions to EPF are automatically deducted from your pay, matched by your employer and remitted to the EPFO, which manages this money.

The EPFO invests most of its corpus in ultra-safe avenues such as government securities, PSU bonds and money market instruments, apart from special deposits with the government. It declares a fixed ‘interest’ every year decided by the EPFO trustees.

In the case of EPF, after five continuous years of contribution, withdrawals are tax-free.

Thus, while the EPF scores on safety and predictability, it is far from flexible during your working years and does not offer inflation-beating returns. To rely on it alone to meet your retirement needs can thus leave you short.

The Public Provident Fund or PPF, open to all individuals through the post office network, is a 15-year scheme which allows investments of up to ₹1.5 lakh a year. Interest rates on the PPF are announced every year by the government.

They have been in the range of 8.6-8.7 per cent in the last five years.

The scheme is one of the few to enjoy EEE status. That is, initial investments are exempt from tax under Section 80C of the Income Tax Act, interest payments are tax-free and so is the final accumulated sum at withdrawal. The PPF is ideal for the fixed income component of your retirement portfolio. If you are self-employed, it should make up the core of your retirement kitty.

NPS

Among the various market-linked retirement options available to investors today, the NPS, overseen by the Pension Fund Regulatory and Development Authority of India, offers a superior option. It allows you to choose between different combinations of equity (up to maximum of 50 per cent), corporate debt and government securities in a portfolio.

The scheme is managed by private as well as public sector fund managers for a fee. You have the flexibility to switch between options and managers based on track record. ICICI, UTI, SBI, Reliance and Kotak have been managing NPS schemes for over five years now. The investments of the NPS are more actively managed compared with other market-linked pension plans in the market. Typically, the equity portion is invested in index stocks.

For the corporate debt portion, AAA-rated securities are chosen. Currently, corporate debt portfolios carry a duration of four-six years and a yield-to-maturity of 8.3-8.5 per cent. In the case of G-Secs too, the preference is for longer tenures of 8-10 years and yields are currently at 7.8 per cent levels.

Thanks to dynamic management, NPS has delivered reasonably good returns. On the equity portion, returns have been 12.8-14.7 per cent annually over the past five years across fund managers, higher than the Nifty’s 12.2 per cent CAGR over this period.

After adjusting for asset allocation, assuming 50 per cent equity and 25 per cent each in corporate and government securities, the returns work out to 11.6-12.7 per cent.

These returns are marginally higher than the average returns of 11.4 per cent delivered by debt-oriented balanced schemes in the market, which are comparable in asset allocation.

Among the fund managers, ICICI and SBI have fared well across asset classes and have been consistent over the years.

In the last five years, on a blended basis, these two fund managers have delivered 12.4-12.7 per cent returns and have been ahead of peers. Kotak has improved performance in the last two years. UTI and Reliance have lagged on their debt portfolios.

At 0.5 per cent per annum, the NPS fee includes fund management fees, transaction costs and annual maintenance charges.

For the first year alone, expenses would be around 1 per cent for registration, account opening, etc. Clearly, in terms of charges, this product charges much lower than mutual funds, which charge about 2.5 per cent and way better than unit-linked plans where the charges can be prohibitive, at least in the initial years.

But where NPS becomes less attractive compared with mutual fund retirement options is on taxation and withdrawal. Investments in the NPS do qualify for tax deductions under Section 80C. But the proceeds on withdrawal are taxable.

Also, at least 40 per cent of the accumulated corpus needs to be converted into an annuity at maturity. In case annuity rates at the time of the investor’s retirement become unattractive, returns would suffer.

Therefore, though the NPS is a good product to accumulate a retirement kitty, it may turn sub-optimal to actually earn a pension. It is here that dedicated retirement mutual funds seem to score over the NPS.

Mutual funds

For a long time, given lack of clarity about regulation and other aspects, the mutual fund industry hesitated to launch any retirement products. Franklin India Pension and UTI Retirement Benefit Plans were the only schemes offered by fund houses exclusively dedicated to retirement until recently. These schemes are essentially balanced funds, which allow you to make lumpsum or SIP investment until the age of 60.

Deductions under Section 80C are allowed. Of the two, Franklin India Pension has done quite well over the past five years with a 13 per cent annual return.

With about 40 per cent of its corpus invested in equity and the rest in debt, the scheme offers a conservative, yet quality, option.

The scheme has been in the top-quartile of the debt-oriented balanced funds category. UTI Retirement Benefit, with a similar allocation pattern, hasn’t fared as well, delivering about 10 per cent in the last five years. Both schemes have a track record of over 10 years. After the go-ahead for MF retirement plans in the July Budget, the menu of MF options is now set to expand. A recent launch has been the Reliance Retirement Plan, which comes with two options — a wealth creation plan and an income generation plan.

The wealth creation plan will invest 65-100 per cent of its corpus in equity and the remaining in safe debt instruments. It will be benchmarked against the BSE 100, which means that the equity bets are likely to be in large-cap or bluechip names.

The income generation plan seeks to invest 5-30 per cent of its corpus in equities and 60-95 per cent in debt. This plan is suitable for conservative investors as it is designed more on the lines of a monthly income plan (MIP).

Switching between the two plans is allowed, without any charges.

Investments are locked in till you turn 60. If you wish to redeem units before this period, you can do so at a modest 1 per cent exit load.

Investments made in the Reliance Retirement Fund are eligible for tax deductions under Section 80C.

But the sweetener is in its wealth generation plan.

In terms of tax treatment, any amount accumulated in the wealth creation plan would be tax-free (provided tax laws on equity capital gains don’t change) as it has 65 per cent of its corpus in equities.

If the income generation plan is chosen, you would have to pay long-term capital gains tax with indexation benefits. Mutual fund retirement plans are transparent, as you can choose or switch between them based on track record.

They are tax-efficient due to the friendly tax structure on equities. They are also the most liquid of retirement funds, given the three-year lock-in and the “no strings attached” at withdrawal.

Where they lose to the NPS however, is on costs. These mutual funds charge about 2.5 per cent annually. But if you choose the ‘direct’ plan, the charges can come down to 1.5-1.8 per cent. Until something better comes along, these products appear to be the best dish on the Indian retirement menu.

Pension plans from insurers

Specially designated pension plans from insurance companies are the most heavily marketed among retirement products.

A wide array of options is given to investors from investing in debt alone to a combination of equity and debt. The equity portion can further be broken into conservative and aggressive bets.

Mostly, immediate annuity products are offered though deferred products too are available.

They combine insurance and investment. So, there is some assurance in case of any untoward happening.

Generally, the assurance is that premiums or a bit more would be returned to the nominee in case of death (about 105 per cent of premium paid).

The premium paying period has to be at least five years.

The unit-linked pension plans have delivered 7-13 per cent depending on asset allocation chosen. But the key problem with these products is the high charges of 9-10 per cent in the initial years.

While these plans usually run for 5-25 years, early withdrawal is allowed with 2-6 per cent surrender charges.

The key drawback of such plans, apart from high costs, is the conditions on final withdrawal. At the time of retirement, such plans mandate that you buy an immediate annuity from the same insurer.

Therefore, your pension will depend on the attractiveness of the annuity rates at that point in time. These plans can safely be avoided as both the NPS and retirement mutual funds fare better on returns, costs and flexibility.

Published on February 15, 2015

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