Priority 3: Pension Plan - Sumit Khedkar

Priority 3: Pension Plan

 

One day you will retire. You will not be able to work. What will happen at that time? Who will provide you money? How will you manage your day-to-day expenses? You should plan your retirement in your thirties itself after that it is too late to plan. In case of pension plan the good thing is the earlier you start the better is the benefits. The most important thing in choosing pension plan is the pension plan must beat the inflation then only you will have enough provisions for the retirement. So, this is our thumb rule, we will evaluate pension plans by comparing them with the inflation rate.  

a. Pension plan from private players: 

We will first evaluate the private players first. Mostly all private players are offering same type of pension plan with some subtle differences. Most of the plans are in combination with insurance; this is a trick to hide low performance. See, we do not need accidental benefits or critical illness benefit with pension plans. We have already covered that risk in a better way in life and health insurance planning. My personal opinion is all private players are there to earn money they really do not bother about social security. Having said that, let's see what they are offering us in pension segment. 

I got following illustration from a leading private sector bank website. 

Pension plan:

Age at entry :40yrs                             Policy term : 20 years

Annual Premium : 50,000                 Premium payment term : 5 years

Assured benefit : 2,52,500 (Only)

 

  

    

In brief, you will be paying 50,000 Rs a year for first 5 years. Your money will be invested in the bank for next 15 years. After that you will start getting pension. And how much is the assured benefits after 20 years of investment it is just 2,52,500!!! Near about the same that you have given to the bank. Bank has utilized your money for 20 years and after that it is giving you the assurance of returning the same amount of money !!. This is indeed ridiculous.  And they advertise “Sir uthake Jiyo” !! with these kind of pension plans!!  

Now, consider the average and best case scenarios given in the above illustration.

In the average case scenario you will get pension of only 10,601 Rs annually and in the best case you will get pension of 49,323 Rs annually. Your accumulated savings will be yours only after your death!

Let’s evaluate this plan with our thumb rule that a pension plan must beat the inflation rate.

The average CPI (consumer price index) is around 7%. Hence the pension plan must return us more than 7% year on year and that too in the worst case scenario. The pension plan explained above gives us 0% returns in the worst case. This plan does not satisfy our thumb rule. 

 

Certainly this option is the worst available option. All private companies are making fool of people. Remember one thing, you must not fail is choosing or designing the pension plan. At the receding period of your career you cannot excuse that “Ohh, I had invested in the pension plan of XYZ bank, but the plan has performed worst, now I do not have money to manage my retirement life.” No one will buy that excuse.

 

b. Design your own pension plan: 

 

Now, let’s see if you would have done pension fund management by yourself with the same amount of money then how you would have performed.

 

Option1: Design your own pension plan with the help of Post Office investment options:

 

We can use post office’s National savings certificate (NSC) , recurring deposit scheme and monthly income scheme (MIS) as instruments for our own pension plan.

Post office’s National savings certificates (NSC) and Recurring deposit scheme give you around 9% year on year returns. There is no limit on the amount you invest and no TDS is deducted in NSC and recurring deposit schemes.

In line with the above mentioned plan suppose you invest 50,000 Rs yearly in recurring deposit ie. 50,000/12 = 4,167 Rs monthly, for the first five years and after maturity you reinvest the maturity amount in NSC and you do this for next 15 years. At the end of 20 years you will get a lump sum amount which you can invest in a monthly income scheme and start getting regular income.

Following table explains the calculations.

Year	Mode of investment	Amount invested	Amount  at maturity
1 To 5	RD for first five years	Monthly 4,167 Rs Total 2,50,000 Rs	3,16,090 Rs
6 To 15	NSC for 10 Yrs	Reinvest 3,16,090 Rs	7,69,739 Rs
15 To 20	NSC for 5 Yrs	Reinvest 7,69,739 Rs	12,01,185 Rs
At 20th Year	Total Returns	2,50,000 Rs	12,01,185 Rs

 

As per above calculation if you follow your own pension plan then at maturity you will have total 12,01,185Rs in your hand which you can invest in a monthly income scheme and start getting yearly annuity of 1,08,106 Rs. Everything is 100% guaranteed here there are no ifs and buts. And the good thing is your seed amount  12,01,185Rs is yours only. In worst case this pension plan is giving you 9% year on year returns hence this pension plan satisfies the thumb rule of beating inflation.

Now, let’s compare this plan with the plan discussed above.

 

Pension Plans	Accumulated Savings	Yearly Annuity	Guarantee	Returns	Remarks
Private bank's pension plan  in best case scenario.	7,38,242  Rs	49,323  Rs	No guarantee	6.50%	Accumulated Savings stay with the bank.
Your pension Plan	12,01,185  Rs	1,08,106  Rs	100%	9%	Accumulated Savings stay with you.

 

 

 

 

Isn’t your pension plan a better plan than the private bank’s pension plan? 

For those who are ready to put extra efforts, there is something more for you.

 

Option2: Design your own pension plan with the help of recurring deposit mutual fund and MIS (monthly income scheme): 

 

In today’s lifestyle as we grow our luxuries become our necessities. For example today a car may be a luxury for you but as you grow you will find it as a necessity. You need more money in the future as compare to your today’s need. Hence you should have a pension plan which gives you robust and guaranteed returns.

If you invest in debt then at maximum you can get 9-10% returns but if you aspire to get more returns from your pension plan then you should invest in equities. In long run equities give you around 15% year on year returns. As horizon of a pension plan is 20-30 years you get a long time period to maximize the returns using equities. And the safest way of investing in equities is investing in mutual funds using systematic investment plan (SIP). 

If I combine these two instruments viz. recurring deposit which gives me guaranteed returns and mutual fund which gives me robust returns in long run then this hybrid investment will give me guaranteed healthy returns. 

 

Let’s see the illustration in the example below.

 

Suppose your current age is 30 and you are investing 10K per month for your retirement.Out of the 10K if you put 5K in recurring deposit and 5K in SIP then after 30 years you will have total 91,53,717 Rs in your recurring deposit account (9% year on year returns) and total 3,46,16,398 Rs in your mutual fund account (15% year on year returns). To get regular pension from your investment you can put the recurring deposit returns in a monthly income scheme (MIS) and can convert the systematic investment plan (SIP) into a systematic withdrawal plan. Following tables will help you understand the illustration.

 

First thirty years of the investment period: 

Year	Mode Of Investment	Amount Invested	Returns	Amount At Maturity
1 To 30	Recurring deposit	5000 Rs per month, Total 18,00,000 Rs	9%	91,53,717 Rs
1 To 30	Mutual fund SIP	5000 Rs per month, Total 18,00,000 Rs	15%	3,46,16,398 Rs

 

Pension period: 

Year	Mode Of Investment	Pension	Returns	Seed Amount
31 To 60	Monthly income scheme	8,23,834 Rs	9%	91,53,717 Rs
31 To 60	Mutual fund systematic withdrawal plan	51,92,459 Rs	15%	3,46,16,398 Rs
	Total pension per year	60,16,293 Rs

 

Here, in any case you are getting 91,53,717 Rs guaranteed returns. The returns from mutual funds may vary.  However, if you invest vigilantly in good rated mutual funds then surely you will get better returns in long run.

 

c. National Pension System: 

 

National Pension System (NPS) is one of the best options available in pension fund management.

The Central Government had introduced the National Pension System (NPS) with effect from January 01, 2004. NPS was made available to All Citizens of India from May 01, 2009. Pension Fund Regulatory and Development Authority (PFRDA), the regulatory body for NPS, has appointed NSDL as Central Recordkeeping Agency (CRA) for National Pension System. CRA is the first of its kind venture in India which will carry out the functions of Record Keeping, Administration and Customer Service for all subscribers under NPS. CRA shall issue a Permanent Retirement Account Number (PRAN) to each subscriber and maintain data base of each Permanent Retirement account along with recording transactions relating to each PRAN.

NPS is offering around 12.5% year on year benefits, being controlled by PFRDA it is the safest and reliable option among all available options. This scheme also fulfills our thumb rule of beating the inflation.

 

You can open a NPS account in three steps.

 

Step1: Point of Presence (POP) :

Points of Presence (POPs) are the first points of interaction of the NPS subscriber with the NPS architecture. The authorized branches of a POP, called Point of Presence Service Providers (POP-SPs), will act as collection points and extend a number of customer services to NPS subscribers.

Almost all national and private banks have been assigned as POP for NPS. You can open NPS account online by using services from HDFC securities http://www.hdfcsec.com/product-services/new-pension-scheme/201008230423175468750

Or from ICICI direct http://content.icicidirect.com/newsitecontent/Home/Home.asp

 

Step2: Choose your pension fund managers:

 

The Pension Funds (PFs) appointed by PFRDA would manage your retirement savings under the NPS.

Following is the list of pension fund managers appointed by PFRDA. You have to choose any one from the list.

• DSP Blackrock Pension Fund Managers Private Limited
• HDFC Pension Management Company Limited
• ICICI Prudential Pension Funds Management Company Limited
• Kotak Mahindra Pension Fund Limited
• LIC Pension Fund Limited
• Reliance Capital Pension Fund Limited
• SBI Pension Funds Private Limited
• UTI Retirement Solutions Limited

 

    Step3: Select your investment options

           You will have the option to actively decide as to how your NPS pension wealth is to be invested in the following three options.

• E - "High return, High risk" - investments in predominantly equity market instruments.
• C - "Medium return, Medium risk" - investments in predominantly fixed income bearing instruments.
• G - "Low return, Low risk" - investments in purely fixed income instruments.

    

    

Auto Choice:

NPS offers an easy option for those participants who do not have the required knowledge to manage their NPS investments. In case you are unable/unwilling to exercise any choice, your funds will be invested in accordance with the Auto Choice option.

In this option, the investments will be made in a life-cycle fund. Here, the percentage of funds invested across three asset classes will be determined by a pre-defined portfolio. At the lowest age of entry (18 years), the auto choice will entail investment of 50% of pension wealth in "E" Class, 30% in "C" Class and 20% in "G" Class. These ratios of investment will remain fixed for all contributions until the participant reaches the age of 36. From age 36 onwards, the weight in "E" and "C" asset class will decrease annually and the weight in "G" class will increase annually till it reaches 10% in "E", 10% in "C" and 80% in "G" class at age 55.

Getting Your Money Out:

Vesting Criteria	Benefit
At any point in time before 60 years of Age	You would be required to invest at least 80% of the pension wealth to purchase a life annuity from any IRDA - regulated life insurance company. Rest 20% of the pension wealth may be withdrawn as lump sum.
On attaining the Age of 60 years and up to 70 years of age	At exit you would be required to invest minimum 40 percent of your accumulated savings (pension wealth) to purchase a life annuity from any IRDA-regulated life insurance company. You may choose to purchase an annuity for an amount greater than 40 percent. The remaining pension wealth can either be withdrawn in a lump sum on attaining the age of 60 or in a phased manner, between age 60 and 70, at the option of the subscriber.
Death due to any cause	In such an unfortunate event, option will be available to the nominee to receive 100% of the NPS pension wealth in lump sum. However, if the nominee wishes to continue with the NPS, he/she shall have to subscribe to NPS individually after following due KYC procedure.

 

NPS is India's answer to the US' retirement scheme- 401(K)-is a government-approved pension scheme for Indian citizens in the 18-60 age group. While central and state government employees have to subscribe mandatorily, it's optional for others.

For more details on NPS you can visit following link.

https://www.npscra.nsdl.co.in/citizens-scheme-informaion.php