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Pension Plans in India Research Team | Posted On Monday, October 01,2018, 02:56 PM

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Pension Plans in India



What are pension plans?

Also called as retirement plans, pension plans are designed to save for retirement. Depending on the type of pension plan you choose, it offers investment and insurance cover.

Once you subscribe to a pension plan, you’ve to start investing a certain amount regularly to accumulate a corpus over the tenure of the plan. Some plans offer you lump sum payment option while some others offer payment in installments. The funds earn interest over the tenure. On maturity, depending on the type of pension plan, you can withdraw the funds either in lump sum or in installments.

If you start investing in pension plans early, you can build a decent corpus to secure retirement life. If chosen carefully, retirement plans give inflation-beating returns due to the power of compounding.

There are a number of retirement plans which can be part of your retirement portfolio like Mutual Funds Pension Funds, EPF, PPF, ULIPs, Annuity plans, and so on.

Retirement plans are also called as pension plans. These offer retired people a regular source of income. Broadly, pension plans, are of three types:

1. Insurance based pension plans

2. Non-Insurance based pension plans

3. Government retirement schemes

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Following is the brief of various retirement plans:

1. Insurance based pension plans:

  • Also called as personal pension plans, these are not provided by employers. These have to be purchased by you through life insurance companies.
  • Your employer will not contribute to this investment.
  • Premiums are invested in funds chosen by you based on your risk tolerance and retirement goals.

There are three types of insurance based pension plans:

i. Deferred annuity plan

ii. Immediate annuity plan

iii. Pension plan with or without life cover

i. Deferred annuity plan:

  • ‘Deferred’ means ‘to delay’. Annuity means ‘fixed payout for the rest of the life’. In a deferred annuity plan, you decide a future date from when you want to start receiving the annuity.
  • In deferred annuity plans, there are two phases: accumulation and income.
  • In the accumulation phase, you have to pay premiums at a regular interval for a specific number of years.
  • At the end of the accumulation phase, you can withdraw 1/3rd of the corpus. With the remaining 2/3rd of the funds, you must compulsorily buy an annuity plan.
  • This will make sure you have regular income for the remainder of your lifetime.

Example: A deferred annuity plan for a term (deferment period or vesting age) of 25 years will begin only after 25 years of contribution to the plan. It means you will contribute premiums for 25 years and receive annuity after 25 years. You can choose to pay ‘single premium’ (lump sum) or a ‘regular premium’ (installments).

Deferred annuity plans are of two types:

a. Traditional Retirement Plans:

The contribution or premiums are mostly invested in debt instruments like government securities.

  • These are best suited for risk-averse investors because of associated low risks.

This is best suited for those who:

  • Have low risk-appetite and don’t wish to take high risks on their investments.

b. Unit Linked Insurance Plans (ULIPs):

ULIP is a life insurance product which gives dual benefits. It provides life cover and investment options to the policyholder.

  • As a ULIP investor, you can choose to allocate investments in different asset classes like equity, debt, or a combination of the two.
  • The quantum of risk is based on the asset class that you choose.
  • You’ll earn returns based on the risk.

ULIPs are best suited for those who:

ii Immediate Annuity Plan:

In immediate annuity plan, you start receiving annuity immediately.

  • To start with, you have to pay a ‘lump sum premium’. You’ll then start receiving a regular ‘payout’, also called as ‘pension’ or ‘annuity’ immediately or a year after paying the premium.
  • The pension is paid for the remainder of your lifetime.
  • The payment frequency can be monthly, quarterly, half-yearly or yearly.
  • Once invested, immediate annuity plans cannot be liquidated or cancelled.

The returns on these plans vary. It is at your discretion. You may either choose to receive higher returns on the annuity plan for few years after which the annuity will be paid at a lower rate.

This is best suited for those who:

  • Have a lump sum at their disposal.
  • Want to receive a regular income after their retirement.
  • Have enough funds set aside for emergencies as immediate annuity plans are highly illiquid.
  • Want to control the quantum of returns they receive.

iii. Pension plan with or without life cover:

Pension plans or retirement plans with life cover pay the sum assured to the nominees if the policyholder dies during the accumulation stage.

Pension plans without life insurance cover only pay the corpus built (contribution made) till date with interest (as decided by the insurer) to the nominees.

See Also: National Pension System

Types of annuity payouts

Annuities have various payout options. You can opt for any of the annuity payouts depending on your financial needs post-retirement. The payouts can be a lump sum or monthly payments. Following are the types of annuity plans:

1. Life annuity:

Life annuity pays the policyholder or the annuitant a monthly pension for the rest of their life. This type of payout gives you the best deal for your investment:

  • It gives you guaranteed income for the rest of your life.
  • If you live long, you receive more than what you invested.

A life annuity can also be called a single life annuity as it covers a single person, i.e. the annuitant.

2. Joint life annuity:

A joint life annuity covers more than one person. It covers both, the husband and wife. A joint life annuity covers all the annuitants for a lifetime. Even if the primary annuitant dies, the joint life annuity pays the secondary annuitants. This policy ends with the death of the final surviving annuitant.

3. Annuity payable for a guaranteed period:

This annuity pays you for a guaranteed period, say 5 years even if you die before this. The plan stops paying annuity either on your death or completion of the guaranteed period, whichever is later.

4. Life annuity with period certain:

Life annuity with period certain promises to make payments until a certain period that is pre-decided, say for 10 years. If you outlive the period, i.e. live more than 10 years, the plan continues to pay you for a lifetime. If you die before the completion of 10 years, the plan will pay your beneficiaries only till 10 years are completed.

5. Life annuity with return of purchase price:

This annuity plan pays the annuitant for a lifetime. On your death, the insurer pays your beneficiaries the purchase price of the annuity plan. The purchase price includes the sum assured, accrued bonus and guaranteed benefits minus the amount already paid. This is for those who want to leave a legacy/estate behind.

6. Inflation-indexed annuity:

An inflation-indexed annuity pays you inflation-adjusted annuities. Every year annuity payable is increased at a certain rate, say 5%. The annuities are not linked to the actual inflation rate but cover the increase in expenses to a certain extent.

SEE ALSO: Retirement Planning In India

Non-insurance based pension plans

2. Non-insurance based pension plans:

Non-insurance based pension plans are better known as work-based pension plans. These pension plans are set up by the employer to help employees save for their retirement. Both, the employer and employee contribute to a retirement fund on a monthly basis. The contribution is directly deducted from your salary.

There are three types of work-based pension plans:

i. Defined Benefit Plan:

In this plan, the benefits are calculated based on factors like years of service left and salary.

ii. Defined Contribution or Money Purchase Plan:

In this plan, the benefits are calculated based on employee’s and employer’s monthly contributions and the performance of investments made with such money.

iii. Hybrid plan:

This is a mixture of defined benefit and defined contribution pension plans.

Government retirement schemes

As a social security measure, the government has launched various retirement plans (pension plans) like:

1. Employee’s Provident Fund (EPF):

EPF is available to all salaried employees subject to the rules laid down by EPFO. The employer and employee contribute a percentage of employee’s basic salary + Dearness Allowance to the employee’s EPF account.

EPF is best suited for:

  • Salaried employees.

2. Voluntary Provident Fund (VPF):

Voluntary Provident Fund (VPF) is a retirement saving scheme wherein you can decide how much you want to contribute periodically. VPF is attached to your EPF account. Thus, it is an extension of EPF.

3. Public Provident Fund (PPF):

PPF is a popular long-term investment which offers capital preservation and attractive interest rates. PPF has EEE tax status. A minimum of Rs 500 to a maximum of Rs 1,50,000 can be invested in a financial year.

4. National Pension Scheme (NPS):

National Pension Scheme or New Pension System (NPS) is a government-backed pension scheme. You have to contribute to a pension account during your working life. On retirement, you can withdraw a part of the corpus and mandatorily buy an annuity with the remaining corpus. This makes sure you have a regular income after retirement. Asset mix can be chosen by you. If you don’t choose, it will be selected based on your age

5. Pradhan Mantri Vaya Vandana Yojana (PMVVY):

Pradhan Mantri Vaya Vandana Yojana (PMVVY) is a government backed-retirement plan scheme available only till March 31, 2020. It aims to provide a long-term income option for senior citizens. PMVVY is operated by Life Insurance Corporation of India (LIC). This scheme gives you an assured pension.

6. Senior Citizen Savings Scheme:

The Senior Citizens Savings Scheme (SCSS) is meant for senior citizens. It offers them a regular income. SCSS is a risk-free tax saving investment option. SCSS offers interest at 8.3% which is paid quarterly.

7. Atal Pension Yojana (APY):

Atal Pension Yojana (APY) is an affordable pension plan launched for the welfare of workers in the unorganized sector, private sector and organizations not providing pension benefit can also apply for APY.

You can draw a fixed pension of Rs 1000, Rs 2000, Rs 3000, Rs 4000, or Rs 5000 on attaining 60 years based on your age and contribution.

8. Tax-Free Bonds:

These are fixed income bonds issued by the government which are meant for long-term investment. These bonds are less risky and have a fixed interest rate. The interest rate paid on bonds is known as ‘coupon rate’. The interest earned is tax free.

9. Monthly Income Schemes (MIS):

MIS is offered by post-offices. Also known as Post Office Monthly Income Schemes (POMIS), it works like a fixed deposit with monthly interest payments.

MIS has a lock-in period of 5 years and currently gives 7.3% interest which is payable monthly. It protects capital and gives a fixed income.

Other retirement plans

1. Monthly Income Plans (MIPs):

Though MIPs invest in debt and equity, a major portion goes into debt. MIP is not tax-efficient if you fall in 20% and 30% tax brackets. To overcome this issue, you can consider investing in Monthly Income Plans (MIPs) of mutual funds.

Mutual Fund Monthly Income Plans aim at offering regular income in the form of periodic dividend payouts (monthly, quarterly or half-yearly). The frequency and quantum of dividend payouts vary and are based on the returns and corpus.

2. Mutual Funds:

Mutual Funds are attractive long-term investment options to grow your savings over the long-term. Mutual Fund houses pool the savings of various investors and invest it in different financial instruments. These are subject to market risks. There are various types of investments which are discussed later.

3. Reverse mortgage:

What if you had a solid retirement plan, but somehow the corpus doesn’t generate enough regular income to cover you, post-retirement? That is when you can try this option, if you own a house. A reverse mortgage is a loan against your house. You pledge your house with a bank and receive a lump sum or periodic payments. These payments are exempt from tax as this is a loan.

4. Pension plans from mutual funds:

The pension plans offered by Mutual Fund houses are good investment options. You can start investing in Mutual fund retirement plans via SIP (Systematic Investment Plan). Opt for Systematic Withdrawal Plan (SWP) to realize your investments and transfer funds to your bank account.

5. Fixed deposit (FD):

A fixed deposit keeps your money safe and gives assured returns on maturity. The best part is that some banks offer additional interest for senior citizens, generally 0.5% higher.

  • The deposit term ranges from 1-10 years. FD can be liquidated before maturity. This will attract a penalty of around 0.5 to 1%.
  • To save tax, you can invest in the 5-year tax saver FD. It qualifies for tax benefit under Section 80C. This FD has a lock-in of 5 years.
  • It is advisable to keep at least 6 months of expenses in a bank FD for emergencies.

Fixed deposit returns:

Interest rates on fixed deposits range from 6 to 8% a year. If you want to save tax, you can consider investing in the five-year bank FD plan, that qualifies for tax benefit under Section 80C. But this scheme is locked for five years and cannot be closed prematurely. Interest rates are lower than normal FDs.

6. Recurring deposits (RD):

Unlike fixed deposits, you need to invest in recurring deposits on a monthly basis. You can divert FD payouts to RD. RDs offer interest up to 6.75%. The term can range from 1-10 years.

7. Cash in savings bank account:

It is inevitable to hold cash for liquidity. Though the savings bank account doesn’t offer great returns, it offers high liquidity. You can earn around 3-4% interest on savings bank account balance.

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