Pension Plans also known as retirement plans are considered to be long term investment plans that allow individuals to receive tax benefits and accrue small savings over a period of time. These savings are then capable of providing a steady income after retirement. The necessity of pension plans arises from the fact that generating savings over the long term is not easy as there is always the possibility of individuals dipping into their savings in case of emergencies or to satisfy immediate lifestyle needs such as vacations, home renovations etc. Pension plans are capable of preventing savings from being affected by such expenses as they cannot be withdrawn till a specific period of time with the option of premature withdrawal only in case of proven emergencies. This limitation can be a boon for a large section of the population providing them with a safety net for their golden years when they are no longer earning a regular income.
Importance of Pension Plans in India
India currently has one of the youngest populations in India in terms of average age and this has been a key positive for rapid growth of the economy. However, numerous studies conducted by agencies in India as well as abroad have shown that only a small portion of the population is actively planning for retirement. This situation, compounded by the fact that a large portion of the currently employed population is not eligible for a pension after retirement, paints a bleak picture for the future. In such a situation, pension plans can be a viable alternative as it enables young Indians to start saving early for their golden years to create a corpus that can sustain them in the future. However it is necessary to note that current pension plans available in India are subject to various types of taxes and a lot of reform needs to be completed before they can act as a viable source of retirement income.
Types of Pension Plans
In India, there are various types of pension plans on offer and these can vary based on the type of investment, style of investment as well as the authority that manages the plan. The following are some key types of pension plans in India that are available through different avenues:
Pension Funds: These are usually debt oriented hybrid mutual funds capable of providing 80C tax benefits that are managed by fund houses i.e. asset management companies. These mutual funds invest a large portion of their capital in relatively low risk bonds, government securities and various money market instruments. The remaining minority portion of the fund is invested in equities and equity derivatives. Being a hybrid fund, pension funds combine the best features of equity and debt investments. Equity investments of the scheme help the pension fund grow when capital markets are witnessing a boom, while the debt/money market investments help the fund contain losses during capital market busts. Being majorly invested in debt and money market instruments, pension funds are taxed according to short term and long term capital gains rules applicable to non-equity investments.
Immediate Annuity Plans: These plans are typically provided by life insurance companies and the pension pay outs and these plans starts immediately after the lump sum premium payment is made. In this case, the applicant has to make a lump sum premium payment when signing up for the immediate annuity pension plan of their choice. These annuity payouts are available as weekly, monthly, quarterly, bi-annual and annual payouts depending upon the policyholder’s requirement or choice.
Deferred Annuity Plans: Deferred annuity pension plans work in a manner similar to life insurance as it requires the policyholder to make regular (monthly, quarterly or annual) premium payments into the scheme for a fixed number of years. The period during which the plan holder makes such payments is termed as the accumulation phase. This money paid into the scheme by the policy holder during the accumulation phase is utilized to purchase immediate annuities which generate payouts once the accumulation phase comes to an end.
Pension Plans with Life Insurance Cover: This type of pension plan offered by life insurance companies features a combination of life insurance cover along with the pension plan annuity payout benefits. As a result, it is best described as a ULIP or unit linked insurance plan. Due to the presence of the life coverage component, these schemes are eligible for tax exemption benefits under Section 80C of the Income Tax Act, 1961. This type of pension plan provides some degree of financial security to the policyholder’s next of kin in case of the unexpected demise of the policyholder. On the other hand, if the policyholder survives the accumulation phase of the plan, he/she would be eligible for annuity payouts as per the policy’s pension norms.
Guaranteed Period Annuity: In case of the pension plans mentioned in the prior sections, the annuity pay outs would occur at specific periods of weekly, monthly, quarterly, annual etc. But these payouts occur only after completion of the accrual phase. In case of guaranteed period annuity, the insurance company would issue payouts after specific intervals irrespective of whether the accumulation phase of the pension plan is ongoing or completed. Such pension plans can issue lump sum pay outs in the 5th year, 10th year, 15th year and so on.
National Pension Scheme: The National Pension Scheme (NPS) was initially introduced as the New Pension Scheme in order to phase out the state and central government pensions offered to government employees. Since its introduction, the NPS has undergone a multitude of changes and currently this scheme is available to non-government employees too. NPS invests in various capital market instruments such as equities, debt and government securities with pre-determined maximum and minimum allocation in each category. Because the scheme exclusively invests in market linked instruments, it does not offer guaranteed returns and the subscriber also has the option of discontinuing his/her NPS subscription as per applicable rules. If the NPS account of an individual is held till maturity, then a lump sum withdrawal may be made at the time of retirement. However, at least 40% of the NPS corpus must mandatorily be utilised to purchase annuities, while the remaining 60% is available for withdrawal. NPS investments also provide subscribers with tax benefits under Section 80C subject to various applicable terms and conditions.
Pension Plan vs. Pension Fund
Many individuals think that pension plan and pension fund are the same thing, but they are quite different. Pension fund is in fact only a specific sub type of the larger pension plan group of products. Moreover, while a majority of pension plans are managed by life insurance providers, a pension fund is managed by an AMC or a mutual fund house. Moreover, the taxation rules of these two are also often quite different. While pension plans offer tax benefits under Section 80C, a pension fund is considered to be a debt-oriented equity fund. Hence, at the time of redemption/switching, the pension fund units are taxed under applicable STCG and LTCG rules pertaining to non-equity investments.
Top Pension Funds in India
There are only a few pension funds available in India at present. The following are the ones that an investor can subscribe to at the moment.
Tata Retirement Savings Fund – Conservative Plan: This is the pension fund managed by Tata Mutual Fund AMC and was launched in January 2013. Since its introduction, the scheme has provided annual returns of over 13%. The scheme features an exit load of 1% or 3% in case redemption or switch of the scheme units is made before the investor reaches the age of 60 years. The scheme features a minimum initial investment of Rs. 5000 as a lump sum, while minimum single investment amount in case of the SIP route is fixed at Rs. 500 for a minimum of 12 installments.
Franklin India Pension Fund: Franklin India Pension Fund launched by Franklin India Mutual fund India AMC as one of the first privately managed pension funds in India. The scheme aims to generate steady returns for investors along with tax savings through investments in various equities, equity derivatives, debt as well as money market instruments. As per the stated objective, this pension fund would attempt to achieve through a debt-oriented strategy with no more than 40% allocation made towards equity-oriented investments.
UTI Retirement Benefit Pension Fund:The UTI Retirement Benefit Pension Fund is one of the oldest pension funds operating in India and it was launched in 2013 by UTI Mutual Fund AMC, India’s first asset management company. The minimum investment required to be a subscriber of this scheme is just Rs. 500 and the scheme has provided annualised returns exceeding 12% since its launch. The scheme features an exit load of 1%, 3% or 5% depending on when the redemption was made. In case the investor is of retirement age at the time of redeeming/switching his pension fund units, no exit load will be applicable.
Taxation of Pension Funds
Pension Funds are mainly invested in non-equity instruments such as bonds, government securities, treasury bills, etc. Therefore, these mutual funds are classified as non-equity mutual funds for the purpose of taxation. According to existing rules, any profits made by an investor through redemption/switch of pension fund units prior to completion of 3 years from the date of unit allotments are eligible for STCG taxation. STCG for pension funds is currently equal to the current income tax slab of the investor and it is added to the taxable salary under “income from other sources” head. LTCG rules of non-equity investments such as pension funds quantify the applicable tax rate at 20% on profits accrued with indexation benefits, while the applicable rate is lower at 10% in case indexation benefits are not availed. Investments made into pension funds are however subject to tax benefits under Section 80C up to the Rs. 1.5 lakhs annual limit.