Annuity and lump sum required after retirement.

Annuity and lump sum required after retirement.

Retirement is the phase of life when you start living for yourself after you are done with all your responsibilities. This is also that phase of one’s life where the income reduces and the expenses increase and the time when your savings will help you. We all know the importance of saving enough for our post-retirement years. However, many of us delay, sometimes till it is too late. Procrastination is a big reason for this, while some people delay saving due to the daunting task of selecting the right product.

There are different investment products available in the market which serve this purpose. Investing towards retirement requires proper asset allocation as one ages as well as selecting the right schemes or products to invest in. Here, we will look at six most commonly used pension products in India, which are solely meant to take care of your post-retirement needs. Each of these products has its own unique features. They come with certain tax benefits which can be availed either at the investing age or/and on maturity.

For some, the returns will be taxable, while some may have rigid lock-ins. Others just may not be suitable for your individual needs. So, before choosing, you should know how each of them works to best fit your requirement.

Let’s look at the structure and features of these products to find out its stability. As they say: No investment product is good or bad, it’s just that the features may not suit all the investors.

1. National Pension System (NPS)

National Pension System (NPS) is a long-term retirement focused investment product managed and regulated by the Pension Fund Regulatory and Development Authority (PFRDA). This is a voluntary, defined contribution retirement savings scheme designed to enable individuals to save systematically during their earning life. The NPS seeks to inculcate the habit of saving for retirement and provide for regular income during the retired years.

NPS suits those who are looking to save for their retirement but are not very comfortable in making investment decisions on their own. In short, those who do not want to actively manage their retirement portfolio of debt and equity, NPS is, perhaps, the right answer. NPS helps make equity and debt asset class available in one place with an option to switch between them with varying allocation. The Life stage option in NPS automatically allocates funds between assets as one ages. Even on maturity, NPS takes care of one’s pension without much active involvement.

The most important advantage that the NPS has had since its very first day is its low cost. Currently, the fund management charge is 0.01 per cent of the funds, just Rs.100 to manage a corpus of Rs.10 lakhs. A low fund management goes a long way in creating a big corpus by eating that much less into the returns generated.

Anyone between 18 and 60 can join NPS. Once NPS matures at age 60, pay-outs happen in two ways: first, a lump sum withdrawal of up to 60 per cent of the corpus can be made, and second, annuity begins on the balance till lifetime. During the deferment period, one has to invest till 60 years and then start getting annuity from a life insurance company on 40% of the corpus, while the balance 60% can be withdrawn(Commuted). The return during the deferment period and neither the annuity (pension) are guaranteed and entirely depends on the underlying asset classes which can be equity, corporate bonds, and government bonds, among others.

However partial withdrawal is allowed which is subjected to fulfilment of certain conditions as below:

• The Partial withdrawal shall be allowed for specific purposes such as higher education of children, marriage of children, purchase or construction of residential house or for treatment of specified diseases.
• Individual should have subscribed to NPS for at least 10 years.
• Maximum of 3 withdrawals during the entire tenure are allowed.
• Minimum gap of 5 years is required between the two withdrawals. However, this condition shall not apply in case of withdrawal for treatment of specified illness.

Tax benefits

The NPS comes with tax advantage on the investing amount, partial withdrawals and on the maturity corpus. The contribution towards NPS is tax exempted U/S 80C with a limit of Rs.1.5 lakhs. A new section 80CCD (1B) has been introduced for an additional deduction of up to Rs.50,000 for the amount deposited by a taxpayer to their NPS account. The entire amount of partial withdrawal from the NPS account is tax free now.

However, on the maturity, the annuity remains taxable, although, out of the 60% commuted as maturity corpus was made partially tax-free by giving tax-exempt status to 40% of the corpus, the balance 20% of the corpus that can be withdrawn still remains taxable. However, one may defer the lump sum withdrawal till age 70, or to avoid paying taxes on this balance, one may also club it with 40% annuitisation amount to buy annuity.

2.    Public Provident Fund (PPF)

The Public Provident Fund (PPF) remains a time-tested long-term investment which invests in debt instruments and it generates a steady income flow. It suits those investors who do not want volatility in returns akin to equity. Since the PPF has a long tenure of 15 years, the impact of compounding of tax-free interest is huge, especially in the later years. The interest rate on PPF is set by the government every quarter based on the yield (return) of government securities. Further, since the interest earned and the principal invested is backed by sovereign guarantee, it makes it a safe investment.

PPF accounts can be opened even for infants, but it has to be operated by adults until the child attains 18 years of age, after which the child can operate the account. There is no maximum age limit to open PPF account. The maximum amount one can deposit every year in his PPF account is limited to Rs. 1,50,000. The tenure for a PPF is 15 years. You need not close your PPF account on expiry of 15 years from the end of the year in which initial subscription was made. They can be extended indefinitely in a block of 5 years, with or without making fresh contributions. Even if the PPF account has a tenure of 15 years, PPF rules allow partial withdrawals only once in every year from the 7^th financial year, from the year of opening account.

Tax Benefit

When it comes to saving taxes, the Public Provident Fund (PPF) is one product a lot of people turn to. The Public Provident Fund Scheme offers attractive interest rate and returns that are fully exempt from tax. PPF deposits come under the EEE (Exempt, Exempt, Exempt) tax category. The deposit amount, interest and withdrawal are fully tax exempt. The contributions towards PPF are also tax exempted up to a limit of Rs.1.5lakhs. However, the subscriber should not deposit more than Rs 1.50 lakh as the excess amount will not earn any interest nor will be eligible for deduction under Income Tax Act. Returns on PPF are usually higher than the returns offered by banks on Fixed Deposits.

3. Employees Provident Fund (EPF)

Under Employees Provident Fund (EPF), an employee has to pay a certain contribution towards the scheme and an equal contribution is paid by the employer. The employee gets a lump sum amount including self and employer’s contribution with interest on both, upon retirement.

The contribution paid by the employer is 12 percent of basic wages plus dearness allowance plus retaining allowance. An equal contribution is payable by the employee also. For most employees of the private sector, it’s the basic salary on which the contribution is calculated. The employee can voluntarily pay higher contribution above the statutory rate of 12 percent of basic pay. This is called contribution towards Voluntary Provident Fund (VPF) which is accounted for separately.

For claiming final PF settlement, one has to retire from service after attaining 55 years of age. The total EPF balance includes the employee’s contribution and that of the employer, along with the accrued interest. Anyone over 54 can withdraw up to 90 percent of the accumulated balance with interest.

Tax benefit

The contributions towards EPF and VPF can be claimed for deduction u/s 80C up to a limit of Rs.1.5 lakhs. Withdrawing the PF balance without completing five continuous years of service has tax implications. The total employer’s contribution amount along with the interest earned will get taxable in the year of withdrawal. The EPFO allows one to access one’s EPF even during the course of employment. Such withdrawals are treated as ‘advances’ and not loans. Such advances are allowed only under specific situations – buying a house, repaying a home loan, medical needs, education or marriage of children, etc. The interest earned on EPF is tax-free.

4. Life insurance pension plans

One may invest in unit-linked pension plans offered by life insurance companies. They offer pension plans that help you save regularly and invest smartly so that you are prepared for uncertainties and are able to fulfil your post-retirement aspirations. These pension plans are flexible. Based on your financial risk appetite, you can choose an investment theme ranging from aggressive to balanced to conservative. You can also switch between funds as your risk appetite changes.

These have not been as popular as other pension plans primarily because of in-built guarantees that they have to provide as per the regulations. This guarantees come at a cost and not only push costs upwards, it restricts the potential of returns. Not only has the insurer to guarantee the death benefit, but also the maturity amount on the vesting age (retirement age). On vesting age, the policyholder is assured of ‘Assured Benefit’, i.e., at least 101 percent of the entire premium paid or the fund value, whichever is higher.

Tax benefit

Pension plans provide certain tax benefit on pension plan available in India, depending on the type of plan chosen.  Under sec 80C of income tax, any contributions towards pension fund can be deducted up to Rs 1,50,000 from your gross income. At the time of withdrawal, you can withdraw up to 1/3^rd of your accumulated pension funds without paying any tax.

5. Mutual funds schemes – retirement focused

There are four mutual funds schemes dedicated to retirement saving – Franklin India Pension Fund, UTI Retirement Benefit Pension Fund, Reliance Retirement Fund, and HDFC Retirement Savings Fund. Although directed towards retirement, these are relatively less exposed to equities, which are considered to have the potential to deliver high inflation-adjusted return over the long term. The lock-in period varies across schemes, typically, 3 percent is the exit-load if redeemed before the age of 58 years and before reaching the target amount. There are no penalties if redeemed after the age of 58 years and one can withdraw the entire corpus.

The main advantage of mutual funds’ retirement products is that you do not have to buy an annuity, as is the case with the NPS or pension plans from insurance companies. Instead, you can opt for a systematic withdrawal plan to meet your regular cash flow needs. Since a part of the withdrawal is your principal, it will be more tax-efficient as well. Also, while the NPS restricts your equity exposure to 50%, with mutual fund products such as the HDFC RSF, you can take a 100% equity exposure.

Tax benefit

Investments in Mutual Fund pension plans, qualifies for Section 80C benefits under Income Tax Act. However, the maturity proceeds of retirement plans are not entirely tax free. Non-equity oriented mutual funds, i.e. the mutual funds where equity allocations are less than 65% are subject to debt fund taxation. Long term capital gains (LTCG) for non-equity mutual funds are taxed at 20% after allowing for indexation benefits. While, the equity oriented funds attract (LTCG) on equity funds which is implemented for this financial year onwards.

6. Atal Pension Yojana (APY)

Atal Pension Yojana (APY) is a deferred pension plan introduced by Pension Fund Regulatory & Development Authority (PFRD) under social security scheme. In the recent times where the interest rate on various financial instruments including savings bank is declining, Atal Pension Yojana, as a pension scheme, offers a guaranteed rate of 8 percent assured return for the subscribers and also the opportunity of higher earnings in case the rate of return is higher than 8 percent at the time of maturity after staying invested in the scheme for 20-42 years. Even if the returns of APY are assured and fixed, unfortunately it comes with an investment (and pension) cap.

Any Indian citizen between 18 years and 40 years of age and have a savings bank account can subscribe for APY. Under APY, there are five plans or options providing guaranteed pension of Rs.1,000, Rs.2,000, Rs.3,000, Rs.4,000, and Rs.5,000 per month by the time the subscriber reaches the age of 60. Based on the amount of pension you choose; the premium amount will be determined. After attaining the age of 60 years, you need to get in touch with your respective bank or post office and submit the request for drawing the pension. Voluntary exit in APY is generally not permitted. However, in case of exceptional circumstances such as terminal illness, or death of the subscriber it can be allowed.

Tax Benefit

The Atal Pension Yojana enjoys the tax benefits exactly like NPS Tax Benefits.

Tax benefit at a glance

Conclusion

Investing towards retirement need not necessarily be from the above six investment options. Remember, there is no one single investment that can be called the best, a combination of more than one may serve the purpose better. None of them are equity-oriented and hence it is better if one earmarks funds through 2-3 equity mutual funds towards retirement needs. The idea is to build a corpus big enough to help you sail through the non-earning period of life.

Ranjith

Dilzer Consultants Pvt Ltd

Reference:

https://cleartax.in/s/partial-nps-withdrawal-tax-exemption

https://cleartax.in/s/partial-nps-withdrawal-tax-exemption

https://www.livemint.com/Money/Fj1g4WkmAOS98lDybe4HWM/New-Pension-System-gets-Tier-II-should-you-invest.html

https://www.hrblock.in/guides/public-provident-fund-scheme/