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Financial planners never tire of saying that you need to “pay yourself first”. This means you must set aside a part of your income for your retirement. The good news is that most salaried people are part of the Employee Provident Fund (EPF) scheme. The bad news: the 12% of the basic salary that flows into their PF accounts every month and an equal contribution by their employer is the only retirement planning they ever do. “For most individuals, the mandatory retirement benefit through employment is their only retirement plan,” warns Amit Gopal, vicepresident, India Life Capital.

What’s worse is that in many cases the EPF is used up for purposes other than retirement—a child’s education or marriage, building a house or even a medical emergency. This takes its toll on the nest egg. Says V. Srinivasan, CFO, Bharti AXA Life Insurance: “Most people dip into their PF accounts much before retirement.” The result: the individual doesn’t have a sufficiently large corpus to sustain his expenses after retirement.

Till a few years ago, government and public-sector employees were eligible for a defined benefit pension, which was calculated on the basis of the last-drawn basic salary and dearness allowance. The scheme is now being phased out. The employees who joined after 2004 are eligible for the New Pension Scheme (NPS), where the pension depends on their contribution (see ABC of NPS). Says Gopal: “Defined benefit plans have been done away in most countries owing to the huge cost to the exchequer in supporting such schemes.”

"Invest your retirement corpus in a proper mix of equity and debt based on your risk appetite." — Anil Sahgal, Director (Strategy) and CIO, Aviva Life

The shift from defined benefit to defined contribution also means a lower pension. Private-sector employees are also members of the Family Pension Fund (FPF), but the contribution is so low that the pension would be peanuts.

This is where the pension plans offered by insurance companies and mutual funds step in to fill the gap. If your employer does not offer you a pension, you can buy a plan for yourself. All contributions to pension plans are eligible for tax benefits under Section 80C of the Income Tax Act. Besides, they offer greater transparency and flexibility to the investor. “The pension plans offered by us offer greater control to the individual, considering the kind of instruments that we can invest in compared with the government-controlled EPF,” says Anil Sahgal, director (strategy) and CIO, Aviva Life.

What he means is that these unit-linked pension plans can invest in equities as well, something that the government-managed pension schemes and the Provident Fund are not allowed to do. “Over 20-30 years of employment, the contributions, however small, have the potential to swell with even small exposure to equities,” adds Sahgal. But while equities lend zing to returns from the pension corpus, they also expose them to market risks. “Unlike government-run guaranteed schemes, pension plans from insurers or mutual funds depend on market performance,” points out Gopal.

More importantly, the individual knows exactly how and where his money is invested and is free to alter the investment mix. Unit-linked pension plans allow an investor to rejig the ratio of debt and equity investments to suit his risk profile and time horizon. When the vesting age is reached, the investor has a choice of withdrawing 33% of the corpus value in lump sum and the balance is invested in an annuity with a life insurance company.

Here again, he has the freedom to customise the monthly pension received. If he opts for a high pension, the corpus is depleted in no time. If he chooses to play safe and keep the corpus intact, the pension received would be very low. Ideally, one should take into account his age and life expectancy and then structure the pension flow in such a way that it is almost depleted by the time he kicks the bucket.

But what happens if you retire in a cataclysmic year such as 2008? If anybody had his nest egg invested in the equity option of a unit-linked plan, the value of the corpus would be 40-50% lower than what he had expected about a year ago. It’s enough to derail even the most well thought out retirement plans.

That’s why financial planners advise investors to start shifting from equities to debt as they approach retirement. One can have a higher equity exposure till 10 years before retirement and then progressively taper down the equity component. “The risk is mitigated if you distribute your corpus across equity and debt,” says Srinivasan. Insurers also allow investors to retain their investment up to three years after maturity. This allows them to ride out of any volatile phase in the markets without having to suffer losses by exiting at low levels.

Besides these unit-linked plans, there are also superannuation schemes. “Since the EPF and gratuity benefits cannot fully replace the income at retirement, many employers have set up superannuation plans,” says Gopal. These schemes are based on defined benefits or defined contributions.

Superannuation works well for high-income earners because the upper limit for such contributions is 27% of the income (basic salary and dearness allowance, if any).

This is higher than the combined contribution under the EPF. “The trustees of superannuation schemes can either manage the investments in the accumulation stage or hand over the investment management to a life insurance company,” adds Gopal.

The much awaited New Pension Scheme (NPS), which will be open even to non-government employees, has generated a lot of interest. Here's what the NPS entails:

Who is currently covered by the NPS?
All central government employees and employees of state governments that have adopted the NPS are part of the scheme.

How does the NPS work?
All members are allotted a unique Personal Pension Account Number (PPAN). They can use this account and PPAN from any location and even if they change jobs.

How will the NPS benefit subscribers?
The NPS is unique in three ways. A subscriber can transfer his account across jobs and geographical locations. At present, with a new job, a person has to create a new account and close the previous one. Secondly, NPS is cheaper. There is no entry or exit load. The cost of management is quite low, ranging from 3 to 5 basis points (0.03-0.05%). Lastly, a subscriber is free to choose the fund manager and investment options.

Who will manage these schemes?
Private pension fund managers (PFM), mostly established Indian insurers and mutual fund managers, will manage the funds once the necessary clearances from the Pension Fund Regulatory and Development Authority (PFRDA) are obtained.

Where will the NPS invest the money?
Each PFM will offer a limited number of simple, standard schemes. One can choose from the following options:
• Invest mainly in government bonds.
• Invest mainly in corporate bonds, gilts and partly in equities.
• Invest mainly in equities; partly in gilts and corporate bonds.

What kind of returns can one expect?
There is no specified rate of return. The PFM will invest savings in a scheme chosen by the subscriber. The returns earned by the PFM on the scheme selected will be credited to his account.

Does one have to pay any fees or charges?
One has to pay the Central Record-keeping Agency (CRA), which will maintain the accounts, and the PFMs that manage the funds.

What are the tax implications of NPS?
The 60% paid lump sum will be taxed at withdrawal, but the annuity part will not be taxed. So there is an incentive for a person to invest as much in annuities as possible. The government is still mulling over the tax treatment of the 60% paid lump sum at the time of vesting.