Ten Things to Know About Pension Plans

8/6/2019 Ten Things to Know About Pension Plans

1/5

Ten things to know about Pension Plans

Sanjay Matai October 12, 2010

Everyone has to think about their retirement and a pension plan would be your safest and best

bet. Here are some tips to help you select the right pension plan for you.

1. How does a typical Pension Plan work?

A typical Pension Plan starts with the accumulation phase - the period from the time you buy aplan until you retire. During this period, you will be paying premiums, which will be suitably

invested. The premiums that you pay will be eligible for tax benefit under Sect ions 80C/80CCC.

When you retire, you can withdraw 25-33% of the accumulated corpus. This withdrawal is tax-free.

The balance amount cannot be withdrawn. It has to be utilized to buy an Annuity Plan. This

Annuity Plan will be the source of regular pension until your death. This is called the annuityphase. The pension that you receive will depend on the interest rates then prevailing and is fully

taxable.

2. What are its plus points?

It is a fairly simple plan; easy to understand and implement. You could just pay your premiumsregularly and forget about it.

Further, it enforces discipline. Since non-payment of premiums could prove expensive, you will

try and not skip any payments. This is good for compulsive spenders.

Even otherwise, this discipline is good. For example, during the market crash, many of youwould have skipped your MF SIPs or ULIP premiums. Had you been forced to continue your


2/5

investments, you would be sitting on handsome gains today after the recent recovery.

Besides, the overall costs are also comparable with other investment products and quitecompetitive.

3. Buying annuity is compulsory

In pension plans, you have to compulsorily buy an annuity plan for 2/3rd of the accumulated

corpus.

Pension plans are a long-term product. Suppose in the interim you have moved abroad anddecided to settle down there. Then you would probably prefer to take this money with you rather

than get some nominal pension in India. Or suppose you need money for your daughtersmarriage. Or there is some medical emergency. These may not be possible for you with a

pension plan.

On the contrary, if you had invested in other investment products, you could have possiblyutilized the money in a more desirable manner. In fact you could have also bought an annuity

plan with this money if need be.

This constraint is a big problem with pension plans.

4. Taxation is an issueTaxation is another problem with pension plans

One, on maturity you get to withdraw only 1/3rd amount as tax-free, whereas in EPF/PPF or

equity MFs you could withdraw the entire amount as tax-free. Two, the pension that you get istaxable.

However, if you had the choice you could have opted for a more tax-efficient option available at

that time.

That apart, even the so-called 80CCC is more on paper only, especially after it was made part ofthe overall Rs. 1 lakh limit under Section 80C. Many of you would easily be exceeding this limit

taking into account your PF, home loan principal, insurance premiums, tuition fees etc.Therefore, you may not be getting any tax benefit from your pension plan premiums.

5. Flexibility suffers

Given that you are tied to one fund for possibly decades to come, the flexibility naturally suffers.

As pension plans are long-term contracts, prematurely exiting from such schemes may notalways be possible or easy. There could be many situations wherein you may want to quit the

plan the fund may not doing well, other investment products may be offering better deals, etc.

6. Low diversificationUnlike shares or MFs, where you would normally have a large portfolio, pension plans are


3/5

typically restricted to only a few. In fact, because the main objective of buying a pension planhad been to save tax, most of you would be having just one pension plan.

Thus, with only a few plans to depend on, the portfolio becomes highly concentrated and hence

the diversification too suffers.

Instead, with the same premium money, you could build a well-diversified and balancedportfolio of about 8-12 mutual funds across different AMCs and types of funds.

7. Pension Plan or Own Investment Portfolio

Pension plans, as discussed earlier, suffer from some serious drawbacks. Instead, given that MFs,EPF/PPF and other such investment products have a lot more to offer, it may be prudent to create

your own investment portfolio rather than buying pension plans.

Besides, in terms of returns, MFs/PPF/EPF and pension plans would usually be at par.

On retirement, you can withdraw the entire amount, unlike the 25-33% in pension plans. Inequity/EPF/PPF, the entire withdrawal is tax-free. In debt funds, there would be long-term

capital gains tax. But, with the indexation benefits, this may be quite nominal/nil.

You can then invest this amount in suitable instruments, which will give you regular monthlyincome while your corpus remains intact. This is what happens in an annuity as well. Your

annuity amount earns interest, which is paid out to you as pension, while the original corpusremains intact.

8. Pension Plan from Insurance Companies

Presently, insurance companies offer pension plans. These broadly fall under two categories:Endowment Plans and Unit Linked Pension Plans (ULPPs).

Traditional endowment plans will invest the corpus only in debt instruments such as government

securities, PSU bonds, etc. Safety is of paramount importance. The returns, therefore, willgenerally be in single digits only.

Of late, since the private companies have been permitted to enter the insurance sector, ULPPs

have gained prominence. Here you have the choice about how you want your money to beinvested 100% equity, 100% debt or some sort of a mix of the two depending on your risk

profile.

Switching is also permitted in ULPP from time to time. Thus, you can change your fund-profilewith your changing circumstances. You may start with equity and later switch to debt as you

near your retirement.

Given the flexibility offered in the ULPPs and the transparency in cost structure, ULPPs usuallyscore over the traditional endowment-type pensions plans.

9. Pension Plan from Mutual Funds


4/5

Mutual funds have only a couple of government-approved pension schemes. You will get80CCC benefits in these plans that you normally dont get with other MF schemes. These are in

the nature of a normal balanced mutual fund, with an equity-debt asset allocation of 40:60.

However, these plans are somewhat restrictive. First, you only have one fund option i.e. 40:60

equity-debt allocation. Second, there is an exit load applicable for withdrawals beforematurity/retirement.

Instead, as mentioned earlier, you could create your own portfolio out of the normal equity anddebt funds. This will offer you much more flexibility and diversification.

Therefore, under the present circumstance these plans may not serve any useful purpose.

10. The New Pension Scheme

In broad terms, the New Pension Scheme (NPS) works as a normal pension plan discussed in thebeginning of this article.

The salient features of the NPS are:

Minimum contribution is fixed at Rs. 6000 p.a. (or Rs. 500 p.m.)There are 3 fund options (max 50% equity; 100% government securities and 100% debt other

than government securities)The flat charges and the annual fund management fees are very low and hence extremely

attractive

The fund is exempt from dividend distribution tax, securities transaction tax, etc. normallyapplicable when buying/selling any securities

The retirement age is fixed at 60

On retirement, you get back up to 60% which unlike the normal pension scheme is

taxable and with the balance you have to buy an annuity. Further, you have to withdraw 10%every year and on reaching 70, you will be repaid the entire balance in your account

If you want to quit earlier, you get only 20% in your hand while the balance gets you the

annuity

NPS is similar to the normal pension plans. It suffers from the same drawbacks: higher tax, lower

flexibility, poor diversification and compulsory annuity. That apart, the commuted amount istaxable. So your own portfolio of EPF/PPF/MFs etc. would still be a better option.

(Note: The provisions of new Direct Tax Code have not been considered as they are still not the

final law and could even see further changes. Besides, it is still 1 years till the new Code maybecome applicable.)

* * * * *


5/5

Documents

Ten Things to Know About Pension Plans