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Pension plans are part of retirement planning of an individual. Retirement planning has become increasingly relevant today where the longevity of life is increasing. The life expectancy in India is presently at 65 years and according to United Nations Population Division World's study life expectancy is expected to reach 75 years by 2050 and then to 85 years thereafter. In this backdrop, today those who are in the age group of 30 years and above could live up to 90 years. And if they retire at 60 years, it means they have another 30 years to live, same number of years of their working life, without working full time for many of these 30 years. With average inflation hovering around 10 per cent, there is an imperative need to look for investment avenues which will fetch enough returns to take care of life style as well as inflation. Therefore, pension plans as an investment opportunity are now a must for every individual who will retire some day.
What is a pension plan?
In simple words a pension plan is a financial plan for setting aside money to be received periodically, say monthly, quarterly, half yearly or annually, to be spent after retirement. Also a pension plan is an annuity which is bought to generate income during retirement. That is, a pension plan is designed to generate regular income for individuals once they retire. It may somewhat replace a regular income like salary received during working life. In India, pension plans are offered by the National Pension System (NPS) introduced at the initiative of the Government of India, by insurance companies, both in the public and private sector and recently by the mutual funds houses. In retirement planning an individual have a choice to opt for pension from the above three sources.
What is National Pension Plan?
NPS, the National Pension System also called as the New Pension System is a voluntary contribution of funds for a continuous period of time (till the age of 60years) to enable investors to draw pension after they attain 60 years of age. The Scheme has been introduced by the Government of India from April 1, 2004, and monitored by the Pension Fund Regulatory and Development Authority.
NPS is primarily for people who do not have the benefit of pension after retirement from service or even those who have the benefit of pension may like to supplement their pension income, because of the uncertainty of the impact of inflation on the income in the sunset years. The scheme gives an opportunity to the investors to build up their pension fund over a long period so that after retirement they can draw pension for their livelihood. The scheme is open to people between age 18 to 60 years.
The amount invested can be made in two funds, Tier I, which is only withdrawable after the age of 60 years and Tier II, where the investor may withdraw during the currency of the period of the scheme. There are minimum limits for investing in Tier I and Tier II but as on date there is no upper limit to invest. Only 60 per cent of Tier I funds can be withdrawn after attaining the age of 60 years and for the balance 40 per cent has to be annuitized. There is no assured rate of return as it is market related. The transaction costs are and other charges have been kept low.
Presently, the tax treatment for contribution made in Tier I account is entitled for deduction from gross total income up to Rs.1.00 lakh (along with other prescribed investments) as per section 80C (as per the provisions of the Income Tax Act, 1961 as amended from time to time). The appreciation accrued on the contribution and the amount used by the investor to buy the annuity is not taxable. Only the amount withdrawn by the investor after the age of 60 is taxable.
Pension Plans from Insurance Companies
Insurance companies offer various pension plans (also called as retirement plans or annuity plans) where a person has to initially invest either a lump sum amount or regular annual instalments/ premiums over a period of time in return for regular income either for life or for fixed number of years depending, upon the plan.
Insurers provide two basic pension plan models, endowment and unit-linked. Endowment plans are also known as traditional plans. Endowment plan is a variant of traditional life insurance which promises the insured a death benefit if an unfortunate eventuality happens and maturity benefit if the insured survives the policy term.
Unit linked pension plans are market-linked pension products offered by life insurance companies. As on date over 60 different types of pension plans from different insurance (both public and private insurers) companies are available in the Indian pension plan market. For easy understanding they can be categorised in to the following broad categories.
Deferred Annuity Plan: In this type of plan, investors do not receive the pension immediately at the end of the term but it is deferred for a time period as desired by the investors. If the investors lives through the term of the policy, then the insurer invests the accumulated amount (consisting of sum assured, guaranteed additions and bonuses) to generate regular income. This option is suitable for investors who are still working and have some more years before they retire.
Immediate Annuity Plan: In this plan an investor invests a lump sum amount in return for a fixed amount throughout their remaining life. This is akin to bank's fixed deposit schemes with quarterly interest income sans the life cover. However, these are not vanilla pension plans. Insurers offer various options under such pension plans. There are different categories of Immediate Annuity plans:
(i) Annuity Certain: In this type of immediate annuity plans the insurers pay a fixed amount of money for a certain number of years.
(ii) Guaranteed Period Annuity: In this type of immediate annuity plans the insurers will pay for a certain number of years as agreed in the plan (say 20 years) even if the investors do not live through the agreed period. For example, if the investor dies after 10 years of investing in the plan, the nominee will receive the pension amount for the remaining 10 years. If the investors live through the 20 years then they will receive the pension all along their lives.
(iii) Annuity for Life: Investors will be paid an agreed amount regularly through their life. This plan also comes with the option of 'return of purchase price' to the beneficiary upon the policyholder's death. The nominees will get the maturity amount plus any bonus upon the death of the policy holders. There is also a life annuity plan where 50 percent of the annuity is payable to the spouse in case of death of policyholder.
The tax treatment for insurance pension plans is on similar lines to that of NPS. Contribution made in insurance pension plan is entitled for deduction from gross total income up to Rs.1.00 lakh (along with other prescribed investments) as per section 80C (as per the provisions of the Income Tax Act, 1961 as amended from time to time). The appreciation accrued on the contribution and the amount used by the investor to buy the annuity is not taxable. The amount withdrawn by the investor after the age of 60 is taxable along with the pension amount available from buying of the annuity is taxable.
Pension Plans from Mutual Funds
As retirement planning is becoming more and more popular and acceptable concept of savings for the future (RBI Annual report of 2011-12 details that 16% of household savings have been diverted to retirement funds/ financial products), mutual funds are also very keen to participate in this segment, with the same tax breaks that competitive products enjoy. There are only a couple of pension plans set up by mutual funds that have got the same tax breaks within Section 80C as their insurance and NPS counterparts. Several fund houses have filed applications for similar pension plans and are eagerly awaiting notifications of tax benefits - which unfortunately is yet to fructify.
There are other retirement savings plans that are offered by fund houses, which are hybrid or asset allocation funds designed to help investors accumulate savings for their retirement. These focus on the accumulation phase whereas a comprehensive pension plan is one that not only helps an investor accumulate savings ahead of retirement, but also provides a steady income from this corpus once he retires. Retirement plans are thus fundamentally different from pension plans.
Mutual funds do not offer annuity products which guarantee a certain income on a periodic basis as they are designed to pass through all market risks, including interest rate risks to investors. Insurance companies, by virtue of their capitalisation, assume this risk and offer a fixed periodic payout by matching assets and liabilities and keeping adequate buffers for contingencies. The rate of return may thus prove relatively lower over long periods of time, although the benefit of an assured return is made available.
What's best for the consumer?
Ideally, an investor should have access to the best fund managers with proven track records who will help him build his corpus during his accumulation phase. Once he retires, he should ideally have access to an annuity plan from a well capitalised firm which gives him an assured income during his golden years. And he should be able to set aside a small portion of his retirement corpus, beyond the amount needed to buy the annuity, to create a portfolio that will help him fight inflation over the 20+ years of a retired life that he needs to plan for. An investor would perhaps therefore be best served by a solution that gives him the best mutual fund products during his accumulation phase, an annuity from a good insurance company post retirement and some hybrid funds as inflation busters in his post retirement life. One can of course argue that there are more effective options than an annuity - like SWPs from MIPs etc. This is where an advisor can step in, understand the needs of the investor better and offer solutions that best fit his or her unique requirements and circumstances.
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