Building Retirement Corpus Consider Pension Plans

For building corpus for your twilight years, which investment options do you trust more? Are pension plan sufficient to save adequate amount to live post retirement life peacefully or one must think of other options as well? The question has gained even more importance after statutory pension regulator Pension Fund Regulatory and Development Authority Bill (PFRDA) gets government node and comes close to realty. Under this, the industry regulator is likely to pave way for better regulation, price rationality, standardization of products, etc. in domestic industry. So it’s worthwhile to look at various pension avenues available today to build retirement corpus. Let’s find out:

Pension Plans offered by Insurance Companies

Like any other insurance plan, pension plans are offered by most insurers for one’s golden years. Under most of them, you have a pay a fixed premium for a certain tenure period, which is decided by the term of policy. This money, after making the deduction on various charges (net premium), is invested by insurer in various instruments, depending on the type of plan.

Here, we can categorize pension plans under two types: Endowment plans and Unit-linked plans. Endowment plans are those, which invest your money in fixed income products. In this case, returns may be low but there is a sense of security, even in cases of market fluctuation and inflation.

The other variant is ULIPs, where the insurer invests the investor’s money in stock markets, balanced funds, and other market-based plans. ULIPs can also be categorized into 'with cover' and 'without cover' plans. 'With cover' pension plans, as the name suggests, are those that comes with a life cover to take care of untimely/ unfortunate demise. This marks the end of pension accumulation period, which can go up to 75 years of age.  The following are few popular traditional pension plans available in market:

After accumulation of amount, you are required to buy annuity, i.e., regular pension. It has been made mandatory by law to use at least two-third or 67% of total accumulated amount in buying annuity from the insurer of your choice. The rest can be taken in the form of lump sum amount (known as commutation of pension). For the same, there are following annuity options available in the market:

• Lifetime annuity without return of purchase price: Under this option, an individual receives pension for as long as he lives. The pension ceases in case of death and contract comes to an end.

• Annuity for life with a return of purchase price: If this option is exercised, an individual will receive pension, till he is alive. In the event of eventuality/ death, purchase price of the annuity is paid out to the nominees/beneficiaries of the person. Purchase price, here, is referred to the maturity amount, which includes the basic sum assured plus bonuses/additions, if any.

• Lifetime annuity guaranteed for certain number of years: Under this option, an individual will receive pension for a certain number of years (as prescribed by the plan), irrespective of whether he is alive or not. A major advantage of this option is that, if the person survives the period defined in the contract, he will continue to receive pension for the rest of his life. For example, if an individual has opted for ‘Lifetime annuity guaranteed for 15 years’, and he meets with an eventuality after 3 years of it, then his nominees will keep on receiving annuity for remaining 12 years (i.e. 15 years less 3 years). In this case, the annuity will cease and the pension plan will draw to a close after the said period of 15 years.

• Joint life/ Last survivor annuity: Under this option, you will receive pension till you are alive. In case of an eventuality, his/ her spouse will get pension. Under ‘Joint life / last survivor annuity with return of purchase price', in case of an eventuality to both the individual as well as his spouse, the purchase price of the annuity is 'returned' to the nominee. Whereas in case of ‘Joint life / last survivor annuity with return of purchase price', if the person as well as spouse have died, the pension will cease to draw to an end and plan will close.

• Deferred annuity plans: These are those annuity options, where a person uses an aforesaid plan of accumulating wealth till his/her vesting age (usually 60 years) and then buy annuity.

The annuity income is held as taxable under standard income tax rules. Beside these above mentioned plans, some companies also offer plans, which have both 'with' and 'without return of purchase price' options. For instance, there are immediate annuity plans, wherein payments begin right away or within one year of retirement. This plan is appropriate for those nearing retirement.  For more details on it, please see an example of ‘Max New York –Immediate Annuity’ mentioned in the table.

New Pension Scheme (NPS)

The Indian pension scenario is dominated by employer-sponsored plans, which has a contribution from employee as well to a certain extent. The New Pension Scheme (NPS) launched in 2009, aims to balance this situation by bringing unorganized sectors into fold. NPS is defined as a contribution pension scheme, open to all Indian citizens between 18-55 years of age, where an individual invests in a pension plan of his choice and get a lump sum at the time of retirement alongwith a fixed monthly income for lifetime. NPS work almost the same way as that of private pension schemes.

In addition to private pension plans, NPS has a ULIP factor attached to them. There are two types of fund management options available and investments can be made across two options, which are as follows:

• Auto Choice (Life Cycle Fund): Under this option, contributions made by an individual are pooled into lifecycle fund and invested as per pre-defined asset allocation plan that changes from time to time. The changes are dependent on the lifecycle of the individual. Pre-defined assets allocations for investors up to 40 years of age are given below:

Assets Allocation in NPS

• Active Choice: This option in NPS allows subscribers to choose not only which fund manager to use but also what asset allocation to go with. Once subscribed, consumers can also change the options by using the switch window, which is available in May, every year.

To lure investors lying at the bottom of the pyramid, the government has come out with a scheme of contributing Rs 1,000 per year to each NPS account opened in FY 2010-11. The scheme has been extended for next three financial years and Rs 1 billion has been allocated for the purpose. The following table provides a brief NPS overview:

NPS Overview

Owing to the low charges levied under NPS, yields are higher almost by Rs 50 lakhs by the end of 30-year period. For retail investors, NPS is clearly a better option because it comes with low charges and flexible fund management options. However, returns may be slightly lower with lower monthly outgo as expenses would be distributed over lower investment.

Employees’ Pension Schemes 1995

This is more of a statutory compliance than an open choice for salaried employees. The Employees’ Pension Schemes (EPS) 1995 is a scheme defined under ‘Social Insurance Scheme’ and run by Employee Provident Fund Organization (EPFO), which takes care of the Provident Fund (PF) of employees.

Under this scheme, an amount equal to 8.33 per cent of actual basic salary (subject to maximum of Rs 6,500) is pooled into EPS account from Employer's PF contribution. Government also contributes to this Welfare Scheme at the rate of 1.16 per cent of basic salary. The contribution under the scheme is mandatory for every EPF member, after 15^th Nov, 1995, i.e., when the scheme was launched. One must have at least 10 years of total services to become eligible for pension. If not, one can apply for Pension Fund Money back (Withdrawal benefit), i.e., as you are not entitled for pension and you may withdraw your transferred money.

The savings are pooled into a pension fund, which will remain invested in public account of government and are distributed at the end as capital return benefits. At retirement (58 years of age), you are entitled to get pension as per the following situations:

Situations when pension can be applied for under EPS

Source: EPFO

Example: Rohit joins a company at the age of 25 years, works there for next 35 years and retires at the age of 60. Let’s assume his basic salary was Rs 10,000 throughout his tenure. Since his basic salary was greater than Rs 6500, the amount that went towards EPS was Rs 541, (8.33 per cent of Rs 6500). After retirement his monthly pension would be calculated by using the formula:

[Pensionable salary X Pensionable service]/ 70

For Rohit, his Pensionable salary = Rs 6500/- and Pensionable service= 35 years (The number of years he was in service, and contributed to EPS). Calculation yields Rs 3,250 monthly pension for Ram.

But this seems to be too low given Rohit could have earned more through aforesaid avenues. Let’s assume instead of EPS, if Rs 541 would have been an SIP in traditional mutual funds-based pension plan fetching 8% on a conservative note. That would have fetched him Rs 11, 59,129. Now, this amount can be used for buying an annuity from LIC under Jeevan Akshay. Using LIC calculator, he would have received Rs 8,143 per month, which is way above Rs 3,250 under EPS scheme. This has happened because of the norm that restricts your contribution to Rs 541 per month, which is irrespective of your drawing capabilities and more importantly, there is no compounding benefit. Pension calculation depends upon your last drawn average salary for 12 months and number of years in service.