Like most of us, the 25-year old, Mumbai-based Chintan Chauhan is worried today. But, unlike most of us, he is the model poster boy for financial planners. The reason: he started early with investing, financial planning and, most importantly, retirement planning. “I have some idea about what I want in life and have worked backwards to buy instruments that suit my risk profile and will help me get there,” he explains. Elsewhere in India’s financial capital, 31-year-old Sachin Shirke has been saving diligently for his retirement. “I bought a pension plan over and above my Provident Fund deductions so that it results in a sizeable monthly income later,” he says confidently.
“Starting early is helpful, as it disciplines one to make regular contributions and gain from longterm investing and savings,” agrees Shyamal Saxena, chief marketing & distribution officer, Bharti AXA Life. Chauhan and Shirke are from different backgrounds but they have one thing in common: they care about their future. However, their comfort levels will dip a bit in the near future thanks to the launch of the New Pension Scheme (NPS) on 1 April this year. NPS is bound to worry people about what they should do with their existing plans.
The reasons are many. Compared with pension products offered by the existing players, mostly insurers such as LIC, ICICI Prudential, HDFC Standard Life and Reliance Life Insurance, NPS’ costs will be much lower for members. The new scheme is more dynamic as it can offer its fund managers a greater flexibility in managing the corpus (which could be as large as Rs 20,000 crore in five years), and it will provide higher security as it is backed by the government. If all this turns out to be true, after Parliament passes the requisite legislation, you and I are likely to rethink our retirement strategies.
Accumulation options for Pension
Which one is for you? |
Saving option
| Advantages
| Disadvantages
| Suitable for |
Pension plan from insurers
| - Flexible, with active/passive participation options.
- Offers tax incentive on accumulation and growth.
| - Returns are not guaranteed.
- High built-in charges during initial years.
| Those in the lower tax bracket.
|
Insurance policies
| - Offers EEE tax incentive.
- Comes with additional cover options to work as insurance, savings and investment.
| - One is betting on survival on maturity.
- Flexibility can lead to misuse for any financial need.
| Those in the higher tax bracket.
|
Mutual funds
| - Regular and long-term savings.
- High liquidity.
| - Capital erodes in a falling market.
- No guarantees.
| Those in higher tax bracket who want income with growth.
|
Bank, small-savings deposits and Senior Citizens Savings Scheme
| - Creates stable and regular income.
- Wide range of tenures can help create income ladder.
| - Interest on payout is taxed.
- Locks you to an interest rate that prevents you to gain from a rise in interest rates.
| Those who want regular income in the short or medium term.
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Who sells what
Insurers: All life insurance players like LIC, HDFC Std. Life, Reliance, Aviva, ICICI Pru and Kotak offer accumulation retirement plans with/without life cover. Allow a minimum Rs 6,000 annual investment with tax deduction under Section 80C.
Mutual funds: UTI Retirement Benefit and Templeton India Pension Plan offer structured retirement funds with 40:60 equity-debt ratio. Give lump sum and systematic withdrawal option on exit.
Post office: Sells National Savings Certificates and monthly income plan with fixed return on maturity.
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Logically, this scenario will spur many of the existing players to either change their schemes or launch innovative products to compete with NPS. This too will lead to a situation where everyone will need to rejig their portfolios to get the best incomes after retirement. So what should you do now? Should you stick to what you have, or shift to NPS? Or should you opt for a bouquet of products, including NPS?
Chintan Chauhan, 25 Mumbai
Employer» Private sector consulting
Pension plan: Investment in mutual funds, insurance plans, PPF and PF deducted by employer.
“I haven’t planned for retirement, but my investments in equity and mutual funds should help in wealth creation. I also contribute towards my PF and have taken a pension plan.”
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At this stage, experts contend that one shouldn’t take a decision in a hurry. As the NPS is new, there are issues that are not clear, and some of them could prove to be a matter of concern. For instance, despite having distributors, there would be no one to aggressively sell it to potential members. Therefore, its corpus may remain low. In addition, it is voluntary and many may simply opt out of it after a while.
This will put pressure on the fund managers to seek new members for the low cost of fund management to be sustainable. Finally, it still needs to be passed in Parliament and there can be changes in the scheme
The existing products enjoy more advantages than NPS. The first pertains to taxation. Since the NPS will follow the EET (exempt, exempt, tax) model, contributions at the accumulation stage will be exempt from tax, but the post-retirement payouts will be taxed. However, in the case of pension products offered by insurance companies, the contributions attract zero taxation and even a third of the corpus enjoys the same status on maturity. Only the remaining two-thirds, which is used to buy annuities, is treated as income in the hands of the receiver and taxed accordingly.
Some post-office deposits and PPF offer complete tax breaks (they follow the exempt, exempt, exempt model), but only for tenures of five years or more. Likewise, the instrument that was once the small savers’ favourite, NSC (National Savings Certificate), attracts tax on the earned interest. Therefore, these instruments can be used efficiently for periodic payouts after retirement by depositing the money at regular intervals. One can ensure a regular, fixed and steady income at a later date, although this may not be enough to beat inflation, which is a non-predictable part of such calculations. “If you think ahead, you can make your tax planning work well towards your retirement planning,” advises Brijesh Dalmia, Kolkatabased financial planner.
_100x100.jpg "Pranav Mishra") Pranav Mishra
- Pranav Mishra
Senior Vice-President & Head, Product and Sales, ICICI Prudential Life Insurance
Retirement is the time when you want to spend your days doing what you love. However, many people are not comfortable because they know their regular monthly income will become irregular. Further, the worry of inflation and managing costs gets the better of them.
If you have a great retirement dream, you know that there is a cost attached to it, you know there won’t be regular income, and expenses will continue to rise, it becomes imperative that you start saving systematically. Planning for retirement is not complicated if one takes a systematic approach. Here are some simple rules that you must remember while planning:
Step 1: Decide how much income you require to live comfortably after retirement. Consider increased medical costs and vacations, but reduce costs like children’s education, and rent, if you own a home. You must map this income base on your current lifestyle.
Step 2: Determine how much you need to save regularly, starting today, to have the right amount.
Step 3: Select the right retirement plan which will help you meet your post-retirement requirements.
Step 4: Start saving now. You will have time on your side and can enjoy the power of compounding.
Step 5: Systematically invest a fixed amount every month.
Retirement planning can be done through pension plans of insurance companies or mutual funds. Because of unique needs, there cannot be a single, straitjacketed approach. However, Ulips bring together the flexibility required for long-term planning with the opportunity for growth. Insurance pension plans also provide you with an annuity, which is a guaranteed income.
Saving towards a retirement kitty is a long-term commitment. The plan should be able to adapt to your different life stages and not be drastically affected by market movements. So you must analyse and understand the financials tools to help you build your retirement kitty.
Begin by selecting a plan keeping in mind your risk appetite, future liquidity needs and understanding of the markets. You need to ensure that your plan provides you with a proper mix of equity and debt elements based on your current and future financial responsibilities, age, your retirement age and so on.
The other critical aspect is the right asset allocation and how it changes with time. A good plan will provide you with an asset allocation after reviewing your age, risk appetite, life stage and other such factors. It will also change your equity and debt proportions according to your life stage and enable you to be less risk averse when you are nearing retirement age. It would be ideal to invest in a plan that can offer your investments the option of capital preservation at maturity. This ensures that your kitty is safe against short-term market volatility.
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One should also remember that some of the existing products are more suited to those who still have a long way to go before retirement. In such cases, one has to regularly change the investment pattern between debt and equity as the latter component should come down with age. Pension schemes launched by insurers on the Ulip format score over NPS in this respect as, unlike NPS, they don’t charge fees for constant shifts between equity and debt, up to four times a year. So you can easily take such decisions regularly, keeping an eye on both the bull and bear phases as well your changing risk profile as you grow older.
Such benefits explain why the existing players are not unduly worried about NPS. Says Manik Nangia, corporate V-P, product management, Max New York Life Insurance: “It’s too early to comment on the new scheme being a threat. But there is enough room for more players.” Experience in the more mature markets has proved that several pension plans can coexist. For instance, in the US, besides the government-sponsored 401(k) retirement plan, individual retirement accounts (IRA) and pension plans from insurers, pension funds of employers and mutual funds manage huge funds.
There is another window of opportunity for the firms. As NPS doesn’t have a structured distribution system, it may be forced to attract institutions for this in the future. Similarly, once the NPS’ corpus grows, the government may decide to invite more fund managers. If so, there will be scope for the pension firms to join NPS as and when the regulator allows it. “We are a player in the distribution as well as fund management in the new scheme, and also run our targeted pension fund,” says U.K. Sinha, chairman & MD, UTI AMC.
Payout—receiving pensions
Which one is for you? |
Option
| Advantages
| Disadvantages
| Suitable for
|
Monthly income plan
| -Highly liquid.
-Tax-free dividend for investor.
-Regular dividends create income.
-Can beat inflation due to small equity exposure.
| -Returns may not be consistent.
-Principal can erode in adverse market conditions.
-Flow can be halted if dividends are not declared.
| Those in higher tax bracket & willing to take risk; who want regular income.
|
Post Office Monthly Income Scheme
| -Assured return.
-Secure because it is backed by government.
-Withdrawal allowed after oneyear lock-in period.
| -Interest is taxable.
-Penalty on premature removal.
-Maximum investment of Rs 3 lakh for individual; Rs 6 lakh for a couple.
| Those in lower tax bracket. Good for consistent returns over six years.
|
Systematic withdrawal plan
| -Benefit of regular income.
-High liquidity.
-Choice of asset selection when choosing the mutual fund.
| -Capital erodes in a falling market.
| Those in higher tax bracket looking for income with growth.
|
Fixed income instruments
| -Stable and regular income.
-Wide range of tenures available for interest-bearing products.
| -May or may not beat inflation.
-Locks you to an interest rate that prevents you gaining from a rise in interest rates.
| Those requiring regular income in the short or medium term.
|
Annuity
| -Stable and regular income.
-Wide variety of annuities to choose from.
| -Treated as income and taxed accordingly.
-Annuity charges vary across providers. One needs to do one’s homework.
| Those in lower tax bracket and preferring regular income.
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Let’s come back to the original question. What should you do now? Our advice is that though annuity is the only structured payout product available, you should look for alternatives that reduce your tax burden until there is a change in the taxation laws on annuities. At present, annuities sold only by insurance companies do not offer tax incentives.
Sachin Shirke, 31 Mumbai
Employer» Kama Jewellery
Pension plan: New Jeevan Suraksha from LIC, to which he contributes Rs 24,000 a year, and puts money in PF.
“I have bought a pension plan besides my PF deduction so that it brings a monthly income after I retire.”
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“It’s an anomaly that needs to be addressed at the earliest. Instead of a nominal income tax rate, they should be treated like long-term gains from equity investing,” says Dalmia. Others think a flat tax rate on annuity is a better alternative than imposing the existing rates, especially when the payout is huge.
Products like mutual fund schemes are important in any pension portfolio if they have the option to route funds in systematic transfer plans, which will assure a steady stream of income flows. If you have an insurance plan with a long-term maturity, it may be a better tax hedge compared with a pension plan from the same company as maturity proceeds from the former are taxfree. In the long run, you need a bouquet of pension products like an investment basket comprising insurance, mutual funds and equities. Agrees Rajiv Jamkhedkar, CEO, Aegon Religare Life Insurance: “There will be different value proposition that each player and product type will offer customers.”
See how NPS evolves in the next few months, understand its pros and cons, and then take a call on it. Also, take a critical look at your plans and understand their value propositions. Only then can you decide on your pension portfolio to ensure that you retire rich.
In the Red Zone
- Kapil Mehta
MD-CEO, DLF Pramerica Life Insurance Company Ltd.
In today’s volatile markets, many people have seen their retirement plans go awry. Preretirees are concerned about maintaining their standard of living after retirement and worry that they have started planning too late.
These are very real concerns. However, it’s never too late to start. In fact, the 10-year period before retirement and five years following it represent a critical time of your investment life. We call this the ‘Retirement Red Zone’. In this zone, the personal savings are typically at their maximum and the investment choices largely drive the ability of your corpus to carry you through retirement with the lifestyle you desire. The Red Zone period is illustrated below and the difference between income and expenditure lines indicates savings.
The following examples show the importance of decisions taken in the Red Zone:
a) Rs 2,50,000 invested at the beginning of the Red Zone at 11% compounded rate would translate into a first-year income of Rs 35,493 on retirement. If the investment rate were 3%, the retirement income would be less than half.
b) If you had Rs 2,50,000 at the start of retirement with a 60:40 equit-bond mix, but reduced the equity exposure to 25% on retirement, your savings could last, on an average, just over 20 years, vis-à-vis 30 years if the original investment mix had been maintained.
The decisions in five years after retirement are also critical. In a downturn it might make sense for individuals to postpone their retirement and generate additional income for a few more years.
For those entering the Red Zone, I would suggest that you:
Seek advice: Meet finance professionals to understand the products available and analyse your investment strategy.
Procure health insurance: Health spends eat significantly into retirement savings. Invest in a health plan early in the Red Zone period.
Consider life insurance: Many retirees continue to have financially dependent family members. Buy a life plan for their security.
Focus on investment options with in-built fund conservation like lifecycle funds that steadily reduce equity exposure with age.
Create cash reserve: Build a small kitty for day-to-day spends. Keep it separate from investment portfolio.
Consider annuities: Annuities with guaranteed lifetime payout can insure against poor returns on other investments.
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