Notes

Outline

And They Lived Happily Ever after Not just in your early days of a married life or in movies, you would hear or think of these sweet words, you got to make things work in such a way that even after you retire, the happy hours continue and you get the opportunity to cherish the memories of your past. In addition to all your immediate needs like keeping yourself adequately insured, making provision for short-term contingencies, savings for your children’s education or marriage, keeping yourself and your family members insured from medical exigencies, there is one another important area that is generally given the last preference - Retirement. Many of us are even put off by the very thought of those retired years. After all, we all tend to keep reminding ourselves that I live for today. Some of the common excuses that we fall upon are - I’m too young to bother about it; My living expenses will be lower after I retire; My retirement assets are safer in fixed-income instruments; Inflation is under control, so I don’t need to consider it when planning for retirement or the most ubiquitous one - I can rely on my children.

Clear and present danger: However, the realities are way apart from the world we think we live in. Life expectancy is on the rise. This effectively means the non-earning period after you retire is going to expand putting that much strain on your monthly expenses. The danger that lies ahead is obvious and cannot be pushed under the carpet. Your monthly expenses of Rs 50,000 in 20 years time at an inflation of 5 percent would balloon to Rs 1.32 lakh. The rise in income may offset this inflationary impact but not to that extent.

Solution: The solution to this lies in the present. Your present is going to decide the shape your tomorrow is going to take. One financial instrument that takes the responsibility to take you through is the pension plan. Pension plans are tax efficient investment plans, which help you in creating a corpus amount by the time you want to retire. Pension plans can be bought either from mutual funds or life insurance companies. There are two such pension plans from MF’s and both are balanced funds in nature with about 60 percent exposure in equities and balance in debt. Templeton India Pension Plan, is one such option that you can consider.  Life insurance companies offer pension plans with varied asset allocation and you may keep even 100 percent in equity or in debt. Equity exposure typically comes from pension plans that are available as unit linked policies. If you are risk averse there are endowment type policies where insurance companies invest in debt. However, unlike the former they give you lower returns since the risk is low.

Traditional Pension: Till a few years back, most pension plans were with-profit or bonus-based. In such plans, the insurers bear the investment risk. Your investment is not at risk, and your returns vary with the profits and surplus, depending on the investment performance of the insurer.  But the flip side is that these policies don’t disclose the investment performance and the costs incurred on fund management or administration. So, you make do with what is offered. Also, since such plans don’t invest in equities, which typically provide high returns in the long term, their returns are in the range of eight per cent.  Pension plans traditionally are with-profits or bonus based and hence the returns hinges largely on the profits and surplus generated by the insurer. The plans currently being offered by insurers can either be bonus based or with ‘guaranteed additions’. It implies, that the returns are not depending on the performance of the insurer and come what may, the additions that are guaranteed would be paid to you.  The returns being a function of the bonuses and since the funds are not exposed to equity markets, the returns would normally be around 8 per cent. If your risk profile does not allows you to take risk by saving for retirement thought equity exposure, such bonus based plans are best suited. Otherwise, the unit-linked pension plans is an ideal vehicle to augment wealth creation for your retirement years.

"Considering the fact that most..."  Considering the fact that most of these private insurers would not be making enough profits in the initial years of business, some of the insurers carry a “guaranteed return” in their offerings. ICICI prudential life insurance’s pension plan, Forever Life, carries a guaranteed return of 3.5 per cent of the sum assured for the first 4 years of the policy. SBI Life provides 4 per cent guaranteed returns on LifeLong Pension bought till March 2010. Similarly, on LIC ‘s Jeevan Nidhi guaranteed additions is Rs 50 per thousand sum assured for each completed year, for the first five years.  Just in case the policyholder dies during the deferment period, the treatment is different in each case. In plans like Forever Life, Jeevan Nidhi, an amount equal to the sum assured along with the accrued guaranteed additions and the bonuses would be paid in a lump sum to the nominee. Nominee will also have the option to purchase an annuity with this amount. However, in case of  LIC’s another pension plan- New Jeevan Dhara – I, on death of the policyholder during the term of the policy,  the basic premiums along with a simple interest is paid to the nominee. Currently, the interest rate is 3 per cent, 4 per cent or 5 per cent if the death occurs within the first 10 years, 20 years or thereafter respectively.  Participatory policies might work for extremely risk-averse people with low income. It may even work for those who want to use it to create a base retirement income, supplemented by income from other sources. But, most of us need the equity exposure that unit-linked pension plan (ULPP) provide.

How does unit-linked pension work: Most of the pension plans works in two phases- first is accumulation phase and later comes the annuity (pension) phase. As a first step you have to decide at which age want to retire, called the vesting age and then decide on the investment amount based on your pension needs. Accumulation phase is the stage where savings, investments or your contributions are made for creating the lump sum amount for the vesting age, the age when you want to start having pension. Once you reach the vesting age according to your pension plan, you can withdraw up to one third of the fund value as a tax-free amount and with rest of the amount you can buy an annuity from the same insurance company. In case, you find the pension amount less, you may shift your corpus to any other life insurer giving you higher pension amount.

Options galore: Most of the pension plans offers both the options of regular or one time premium. In one time premium you have to make a one-time payment of the premium, however some of the pension plans allows you to invest additional amounts as a top up amounts. Minimum entry age for almost all the pension plans is 18 years; however there is a difference in maximum age of entry.  Maximum age of entry in SBI Life Horizon II Pension is 60 otherwise many other plans gives the option up to maximum age of 65 years. If you enter the pension plan late in your life there would be very less time left for your pension fund to grow.  You can decide age of retirement or the vesting age. And even after fixing it, many plans gives you the option to extend it further.

"You have to decide whether..."  You have to decide whether you want life insurance cover along with pension plan. ICICI Prudential’s Life Time Super Pension Policy gives the option of taking minimum life cover of Rs 1 lakh or annual premium multiplied by policy term. In case of unfortunate death of the policyholder, nominee will receive the higher of sum assured or fund value. Some plans are pure pension plans and do not provide any life cover at all. In them, the fund value is paid to the nominee if the policyholder dies in the midway of the policy.  After paying the premium then they are invested in one of the funds chosen by you, all the pension policies allows you to switch between the funds according to your risk appetite.

Essentials of a pension plan: Although the structure of a pension plan is almost the same of all insurance companies, choose pension plans, which are unit-linked in nature. They have a potential to deliver higher returns and come with flexibilities. Look out for plans that have minimum fund management charge. This charge goes a long way in determining the actual wealth on retirement. Do not attach life cover in the pension plan. Attaching a life cover would amount to deduction of mortality charges from your investment, which in turn leaves fewer amounts to be invested towards pension. Keep insurance and pension separate. Pension is a long-term product and equities perform the best over long term. Keep invested in fund option with 100 percent equity exposure during your initial years. Before retirement, shift the funds to debt option.

How to choose the best one: The amount of money that a person invest in a ULPP, and will end up with during retirement depends on three factors—costs such as those for management and administration, fund management performance and the market growth over the years. Costs are important as they eat into your premium contribution before the remainder can be invested. Thus, the lower the costs, the better the chances of higher accumulation.  Various companies structure or spread the costs differently during the tenure of their plan. The structuring may even differ with plans from the same company. Out of the three factors, while fund management and market growth are prospective in nature and beyond your control, you can research on the cost structure of various ULPPs—information that the insurance advisor can give you—before you invest.

"However," However, that is a daunting task for someone to actually go through the entire charge structure and understands their impact. Consider speaking to few agents of various insurers and get the illustration benefits based on parameters as required by you. For example, at your age for a particular term and for a certain amount of premium, compare the final corpus that gets accumulated. The illustration benefit would show this corpus amount over all the same parameters for you to arrive at a conclusion regarding the best plan. The plan with highest corpus at the vesting age undoubtedly, has the least cost or charges over the term of the policy.

Conclusion: Since most of the ULPPs right now have a very short track record, it makes sense to supplement it with the fund performance to find out whether the company can really deliver on its projections. An important point to remember here is to factor in the equity exposure since it makes a difference to the returns. For instance, an insurer might have a maximum equity exposure of 60 per cent; while another can have 100 per cent exposure. See table: Performance that showcases the returns of such plans in the market.