Do you struggle when you have to select a retirement plan and investment option?

• Here is a short note on pension plans and mutual funds to assist you in making an informed choice that suits you and your personal requirements.

Retirement / Pension Plans and Mutual Funds – The fundamentals you need to understand
When life insurance firms discuss retirement plans and pension plans, they are addressing bundled products that provide the combined advantages of insurance and investment.

1. Deferred pension plan – This kind of pension plan consists of two stages – the accumulation stage and the distribution stage.
   
   a. Accumulation Phase – During the initial phase of the plan, you must pay premiums, and the money builds up throughout the duration of the plan period – creating a retirement corpus. When the duration of the pension plan concludes, the accumulated funds are used to purchase an annuity. If, during the accumulation stage, you have invested in a pension plan from an insurance provider, then it is mandatory to invest at least one-third of the amount received from this instrument in an annuity at the retirement point.
   
   b. Distribution Phase – After this period has concluded, meaning when your policy matures, you may start withdrawing money from the retirement corpus for monthly expenses. This is referred to as the distribution phase. If you initiate investing at 30 years old, planning to retire at 50, and assuming you live for another 30 years after retiring (until age 80), the accumulation phase will last 20 years, while the distribution phase will continue for 30 years. Be aware that in most retirement plans, the age at which you will commence receiving a pension (known as the vesting age) typically falls within the 40-70 years age range. Since your targeted retirement age is 50, you are well covered in this regard. The timeframe when an individual receives a pension is also called the annuity phase.
   
   2. Immediate annuity plan – In this retirement scheme, the investor may pay a lump sum, rather than contributing over time, and can start receiving income right away. The frequency of payments can be monthly, quarterly, semi-annually, or annually. There are various annuity plans available in the market, each with its options: for instance, the steady monthly income, the increasing monthly income,

The ‘Why’ and ‘Why Not’ of Pension Plans?

1. Guarantees continuous income post-retirement – The primary benefit of pension plans with a deferred annuity is that it guarantees continuous income after retirement; in other words, it offers you the assurance that you will receive a pension every month for the entirety of your life. You can also determine the frequency of payouts – monthly, quarterly, yearly, based on your needs.
2. You need not consider making an investment at the time of your retirement – This is a significant advantage since a new investment with X amount of money 20-30 years later may not yield the same interest it would have accrued now. In reality, you might need to invest more money to achieve the same pension amount.

Disadvantages of Pension Plans

1. Funds are locked until maturity – You cannot make withdrawals during emergencies or if you wish to transition to another investment option in between. The National Pension Scheme (NPS) permits a maximum withdrawal of up to 60% of the corpus at retirement age, and the remainder must be invested to purchase the annuity.

• Additionally, some portion of maturity amounts is taxable, which indeed makes it less appealing for investment.

2. Payments are made with simple interest calculations – whereas all the minor savings schemes like PPF, EPF, etc. provide you with the benefit of compounding the money. Thus, the interest rate of any pension plan is rather low – around 6%-7% – insufficient to even surpass the inflation rate. Conversely, minor savings schemes like PPF will offer you a better return.

The ‘Why’ and ‘Why Not’ of Mutual Funds Advantages of Mutual Funds

1. With this long-term investment, you can withstand short-term fluctuations – The benefit of equity funds is that as you are investing for the long term, you can endure the short-term fluctuations and achieve higher returns.
2. Aids in tax savings – Choosing an ELSS (Equity Linked Savings Scheme) Mutual Fund will also assist in tax savings under 80C and support growth. It is recommended to avoid MFs that exclusively invest in large caps, as their returns are low (approximately 10% annually); since the investments are intended for the long-term and for retirement objectives. It is advisable to opt for a combination of large caps as well as midcaps (where returns are more favorable at 14%).

Disadvantages of Mutual Funds

1. Do not provide death benefits, and your nominee receives only the market value of the fund – Furthermore, equity funds are volatile in the short term and occasionally the risk may not justify the returns – especially since the investment goal is not profit but is part of your retirement planning.
2. High exit loads for early redemptions – Mutual fund companies impose high exit loads for early redemptions to discourage withdrawals before retirement. Be sure to review the exit penalties if you decide to pursue mutual funds.