29 July, 2015

Buying pension plans is not retirement planning!

At a certain point in life we do get jittery about the years we spend in retirement. For most people, that point comes somewhere in forties. For some of us the realization hits us in our fifties. We then hit the panic button.

All of us realize that we need a good corpus in retirement. But most of us underestimate how much we need.

And there comes along an insurance agent, who converts the butterflies in our stomach to cash in bank – for him – by selling pension plans as the panacea for a well-funded retirement!

Pension plans mean retirement

Pension plans are directly connected to retirement. It seems natural to plan for retirement through pension plans. That seeming connection has been wonderfully exploited by insurance companies to sell huge pension policies to those who are in the panic mode. Holding one’s head high in retirement & living with dignity is a theme that has gone down well with this crowd.

People feel safe after doing these pension policies and heave a sigh of relief after they have half a dozen policy documents in their hands. Have they really done the right thing? One needs to know a bit more about pension plans…

Knowing about pension plans

Pension plans have an accumulation phase when one needs to contribute regularly towards building the corpus. Around the time one retires, the corpus accumulated would be used to pay a regular income called Annuity. The annuity is typically the interest income being distributed back to the policy holder. But the distribution is low – just 5-6% on an average. In some cases, it goes to 7% or more.

The problem with a pension plan is that in the accumulation phase, the corpus grows only by 4-6%, ensuring that the final corpus is rather puny. This is what happens in the traditional pension policies.

There are unit linked pension policies where the corpus growth can be faster, but is subject to the vagaries of the market. The policy holder is going to bear the market risk here. Potentially, these policies accumulate to a much bigger corpus and hence the annuities can be better.

Also, the pension policy premiums are eligible for tax deductions under Section 80C, which is a talking point and a prime selling point for the agents.
Sounds fine to you? Wait till you hear about the taxation…

 The taxing issue

Unlike all other insurance products, pension products accruals are not tax free. This is a vexing problem regarding pension products. Due to the income tax, the actual returns will be very low indeed, as the gross returns itself would be 5-6%. After tax, it will be even lower and will fare poorly in comparison to the other investment options.

There have been representations on this to the government and it is being considered. But, when it will see the light of the day is an open question. Hence, the current situation is that the pension income is taxable.

Now what…

If pension plans don’t appear that great any longer and you are again panicking, help is on the way. Stay with me…

The fundamental thing is that you need not plan retirement through pension policies. In fact, it is quite an inefficient way of planning for retirement – so much so that, you are sure to be underfunded if the main or the only way by which retirement planning is done is through pension plans.

The main thing in retirement is sustained income. That can be set up if there is a good sized corpus there, in the first place. There are several accumulation methods during one’s earning phase – investing in direct equity / equity oriented mutual funds in a regular, sustained manner would help in corpus accumulation at a faster clip. PPF is another good tool to accumulate for retirement.

Employee PF & other retiral benefits are not to be used and should be kept aside exclusively for use in retirement.

Sustained income can be setup using tax free bonds and systematic withdrawal from debt mutual fund schemes. These two are very tax efficient. Systematic withdrawal from debt funds is completely flexible & lends itself to increased or decreased withdrawals, in times to come.
There are other traditional investment options like bank FDs, Post Office MIS, Senior Citizen Savings Scheme etc., which would also offer interest income & may still work reasonably well for those in the lower tax brackets or nil tax bracket.

Some people also depend on rental income. But administering a property in retirement is not the best way to have a peaceful retirement – with all the headaches surrounding it. Also, the rental yield in India is about 2%, on an average. A person in retirement is hence well advised to cash out the property and invest in a financial asset from which to earn income in a hassle free manner and at a much higher level.

We can hold our head high in retirement only if we plan well. Else, it will be a retirement where we need to cut corners, depend on others & generally feel miserable. We don’t want to be there, do we?

Article is published on Moneycontrol.com on 29th Jul-15

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