Retirement Planning – Investment Options

1. Retirement investment options

I.        Public Provident Fund (PPF): Overview

PPF is a good fixed-income investment for high tax payers. PPF is a very attractive fixed income investment option for small investors primarily because it provides 8% post-tax return. It also provides a tax rebate of 20% of the amount invested from your tax liability for the year, subject to a maximum of Rs 70,000. Interest received is also totally tax free. The interest earned on the PPF subscription is compounded; that means you not only earn interest in the money you put in, but you earn interest on the interest earned too. All the balance that accumulates over time is exempt from wealth tax.Moreover, it has low risk – risk attached is Government risk. PPF is available at selected post offices and banks.

The problem with PPF is its lack of liquidity. You can withdraw your investment made in Year 1 only in Year 7. However, loan against investment is available from 3rd financial year. If you are willing to live with poor liquidity, you should invest as much as you can in this scheme before looking for other fixed income investment options.

II.        National Saving Certificate

National Savings Certificate, also known as NSC, is a tax saving instrument that combines adequate returns with high safety. NSCs are an instrument for facilitating long-term savings. It provides an interest rate of 8 % per annum compounded half yearly. Period of maturity of a certificate is six years. Premature encashment of the certificate is not permissible except at a discount in the case of death of the holder(s), forfeiture by a pledge and when ordered by a court of law. They not only save tax on their hard-earned income but also make an investment which is sure to give good and safe returns.

A NSC can be bought by an adult in his own name or on behalf of a minor, a minor, a trust, two adults jointly or Hindu Undivided Family. NSC is available for purchase/issue at all Post Offices in India. Nomination facility is available for NSC. Certificates can also be transferred from one post office to any other post office. Transfer from one person to another person permissible in certain conditions.

Certificates are available in denominations (face value) of Rs. 100, Rs.
500, Rs. 1000, Rs. 5000 & Rs. 10,000. The minimum amount of investment under NSC is Rs 100/-. There is no maximum limit for purchase of the certificates. Interest accrued on the certificates every year is liable to income tax but deemed to have been reinvested. NSC can be en-cashed/discharged at the post office where it is registered or any other post office.

Income Tax rebate is available on the amount invested and interest accruing every
year under Section 88 of Income tax Act, as amended from time to time. [under Sec 80C] Income tax relief is also available on the interest earned as per limits fixed vied section
80L of Income Tax, as amended from time to time.

III.        NPS

NPS is a pension plan where you can invest during your working years and withdraw when you retire. Until May 1 2009, the plan was available for central government employees only. But it is now open for the citizens of the country. NPS works like a mutual fund (MF). If you want to invest in the NPS, you can choose from three funds or a mix of funds.
If you are confused about how much to invest in which fund, you can leave it to the auto selection option. Through this option, 15 per cent of your money will be invested in equity, 45 per cent in corporate bond and 40 per cent in government bonds. However, after 36 years of age, your equity and corporate bonds exposure will reduce, but it will be compensated with higher investment in government bonds. The maximum cap in government bonds will be 80 per cent. Equity and corporate bonds will have 10 per cent each investment proportion.

These funds are managed by six asset management companies (AMC): State Bank of India, UTI, ICICI Prudential, Kotak Mahindra, IDFC and Reliance, appointed by the PFRDA. You have the liberty to choose, change your fund manager every year unlike mutual fund or unit linked insurance plans where you are tied to the same fund manger throughout the term of the product.
All AMCs have to follow the guidelines laid out by PFRDA since it’s the ruling authority.

If you are investing in the scheme, you will have to make a compulsory contribution of minimum Rs 6,000 annually or Rs 500 every month. One also has the flexibility to make weekly contribution, but it would involve transition cost, hence it is better to stick to minimum transactions.

The minimum age to enter the scheme is 18 years and the maximum is 55 years.
The best thing about this scheme is the fund management charge, which is a bare minimum of 0.0009 per cent! That is nowhere close to the charges by mutual funds or unit linked insurance companies which range from 1.5 per cent to 2.5 per cent per annum.
The application form will cost you Rs 40 and for every transaction you make and you will have to shell out Rs 20. Switching to another fund will cost you another Rs 20. However, you cannot make more than one switch every year. Apart from this, you will have to pay Rs 350 as annual maintenance charge to National Securities Depository Ltd. (NSDL), which is the central record keeping agency for all the individual pension accounts.

Unlike retirement plan options, NPS doesn’t offer tax benefits under section 80 C and that’s the biggest drawback of the scheme. Currently, NPS falls under Exempt-Exempt-Tax (EET) system. This means that the maturity benefits that you will receive at the retirement stage will be taxable.

Payments will be made once you reach 60 years of age. A part of your invested money (maximum of 60% of your corpus) will be paid out to you as lump sum, and the balance will be mandatorily kept back as annuity. This annuity, which is the remaining amount left in your account, will be paid out to you as pension every month or year depending on what you choose. In case of your untimely death, your nomination will receive this pension.

To make the New Pension System (NPS) dynamic, Pension Fund Regulatory and Development Authority (PFRDA) has introduced the concept of Tier-2 account. This is to provide for withdrawals to meet financial contingencies. Opening the Tier-1 account is compulsory for everyone opting for NPS. However, the Tier-2 account is optional for the investors, as it is a voluntary savings account from which the investor can withdraw money, any time and any number of times.

At first, one may find various problems in NPS but most of them are designed to make it a pure long term pension plan. Some of the major drawbacks include the tax treatment, though it is anticipated that in coming times this will be rectified. With introduction of type II accounts, the problem of no-withdrawal has been resolved. Some may see the limit of 60% for withdrawal as a big problem but it has been kept to prevent you from misusing (using it for anything other than retirement) your retirement fund. In theory this may not look good but, in practice, it will be beneficial for the investor.

IV.        Insurance

Life insurance is a contract between the policy owner and the insurer, where the insurer agrees to reimburse the occurrence of the insured individual's death or other event such as terminal illness or critical illness. The insured agrees to pay the cost in terms of insurance premium for the service. Specific exclusions are often written in the contract to limit the liability of the insurer, for example claims related to suicide, fraud, war, riot and civil commotion is not covered.

Life insurance ensures financial protection on accident or death.  It enables maintenance of the same lifestyle even after the unfortunate demise of a loved one. The beneficiaries can utilize the monetary benefits to replace the income one would have earned or help pay off debts or other expenses. Life insurance boost confidence to the insured, offers satisfaction of being covered for illness, life or financial loss.
The benefits of life insurance are:

• Covers death or critical illness.
• Covers financial interests of the family on the death of the policyholder.
• These product also have inbuilt wealth creation propositions. The customer benefits on two counts and life insurance occupies a unique space in the landscape of investment options available to a customer.
• Life insurance products offers specific tailor made products for different life stages.
• They offer retirement plans.
• A few products offer loan facilities against the plan.
• Last but not least life insurance premiums offer tax saving benefits.

There are two kinds of life insurance policies namely the term life policy and permanent life policy.

Term Life Policy

Term life insurance policy covers risk only during the selected term period. Under, Term Life contract the insurance company pays a specific lump sum to the designated beneficiary in case of the death of the insured. These policies are usually for 5, 10, 15, 20, 25, 30 or 35 years. Term life insurance is very popular in advance countries but is not so in India. However, after the entry of the private operators and aggressive marketing by some players this product is becoming popular. The premium on such policies is comparatively lower when compared to the whole life insurance policies, mainly because these policies do not carry the cash value. The drawback of the policies are, if one survives the period of the policy, the insured does not get any return at the end of the policy. The premium on such policies becomes expensive with age mainly because the risk of death of is higher with age. Once over 60 years, these policies become difficult to afford. If the premium is not paid within the grace period, the policy could lapse without acquiring any paid-up value. These policies help fetch tax saving benefits.
Permanent Life Insurance

Whole life policy is effective until the policyholder is alive. Risk is covered for the entire life of the policyholder, therefore are known as whole life policies. In Permanent Life contract, a portion of the money paid as premiums is invested in a fund that earns interest on a tax-deferred basis.  Over a period of time, these investments are supposed to accumulate increased cash values which you will be able to get back either during the period of the policy or at the end of the policy or at intervals, depending on the policies. Your need for life insurance can change over a different stages of life. You should consider your circumstances and the standard of living you wish to maintain for your dependents. Your life insurance premium is based on the type of insurance you buy and your chance of death while the policy is in effect. This type of policy not only provides security to your dependents by paying a death benefit upon death, but also enables you to use some part of the money when alive or at the end of the policy. The premiums of such policies can be expensive and when premiums not paid on time can lapse the policy. So to get the full fledged benefits paying the premiums on time and having a nominee is important. These policies have can help you fetch some tax saving benefits.

1. Regular Income Needs

I.        MIP

Monthly income plans (MIP) are low risk mutual funds which invest in debt securities and deliver regular monthly income to investors. Monthly incomes are normally fixed term plans and appropriate for investors who seek regular risk free income over a period of time.

Income Funds in India usually invest their principal in securities of fixed income such as government securities, bonds, and corporate debentures. There are many mutual funds houses that have launched Income Funds in India. The advantage of Income Fund is that it provides regular income to the investor either on a monthly or quarterly basis. Further the advantage of Income Funds in India is that it also provides stability of capital to the investor. The bonds that are there in Income Funds are usually of the investment grade. The other bonds are of such credit quality that they assure the protection of the capital.

II.        NPS

As mentioned earlier, NPS can be a good source of income for the individuals after the retirement. In NPS, payments made once you reach 60 years of age. A part of your invested money (maximum of 60% of your corpus) will be paid out to you as lump sum, and the balance will be mandatorily kept back as annuity. This annuity, which is the remaining amount left in your account, will be paid out to you as pension every month or year depending on what you choose. In case of your untimely death, your nomination will receive this pension. So, if you are looking out for a regular source of income after your retirement, NPS is a good investment.