Pension Plans

 

Introduction to pension plans

Most people tend to think that life post-retirement is an idyllic period when one can put up one’s feet up and enjoy all the things that they missed out on while they were working. Very often, however, the truth is starkly different. For many, life after retirement becomes a bit of a struggle.

As regular income stops, it forces adjustments and changes in lifestyle and often the daunting prospect of dependence on others, mostly children, for support. All of this can be avoided by planning for retirement in a systematic manner and from relatively early in one’s career.

In the Indian context, the need for systematic retirement planning is even more acute, given the fact that as much as 87 per cent of India’s workforce of 425 million has no formal pension cover. The absence of any form of meaningful social security further compounds the problem and if we add to this mix rising inflation and increasing costs of healthcare and a substantial increase in average life expectancy in the coming years, retirement begins to appear less idyllic.

People begin to dread rather than look forward to their retirement. Given this scenario it is no surprise that Pension Plans or Retirement Solutions are finding favour with consumers and are increasing as a proportion of life insurance sales. However, in speaking with consumers, it is quite evident that there is still a lack of information and education with regard to the category.

Pension plans offered by life insurance companies help individuals plan effectively for their retirement. For, it is pension plans that provide individuals with a regular income in their golden years.

However, since the tax benefit on such plans is limited to Rs 10,000, investments in such plans have been somewhat subdued. Apart from the tax benefits, it is important that individuals evaluate pension plans from a retirement planning perspective.

What are pension plans?

Simply put, pension plans (also referred to as retirement plans) are offered by insurance companies to help individuals build a retirement corpus. On maturity this corpus is invested for generating a regular income stream, which is referred to as pension or annuity. Pension plans are distinct from life insurance plans, which are taken to cover risk in case of an unfortunate event.

Pension plans Comparison

Conventional pension plans invest a major portion of the premium monies in bonds and government securities (G-Secs). That is why the returns are on the lower side. And if one were to factor into the equation an annual inflation figure of approximately 5%-6% per annum, then the real return figures look even more unimpressive.

This is where unit linked insurance plans (ULIPs) can play an important role in the retirement planning exercise. ULIPs have a mandate to also invest a portion of the premium in the stock market apart from bonds and G-Secs.

Studies have shown that from a long-term perspective, equities are equipped to give a higher return vis-à-vis other fixed income instruments like bonds and G-Secs.

And since retirement planning is a long-term exercise, individuals would do well to consider investing a portion of their retirement money in pension ULIPs.

Pension ULIPs: How they fare?

Having said that, it is also important that investments in ULIPs are made after considering expenses like fund management charges since this will impact returns over the long-term. Also, don’t lose sight of your overall equity allocation.

For example, if the individual has already invested a significant amount of his money in stocks and equity funds, then he might be better off investing in a conventional pension plan from a diversification perspective.

ULIPs other important benefits like liquidity. You can withdraw money from a ULIP to meet emergencies. Also, you can invest surplus money (i.e. top-ups) over and above the premium amount.

Some insurers have launched capital guarantee ULIPs. Such products aim to guarantee the premiums paid by the individuals (net of expenses) plus the bonus declared, on maturity. Individuals, who fear ‘loss of capital’ in a ULIP, will find such products attractive.

However, capital guarantee ULIPs have lower equity exposure which could dampen returns for the aggressive investor.

Pension ULIPs: How they fare?

Having said that, it is also important that investments in ULIPs are made after considering expenses like fund management charges since this will impact returns over the long-term. Also, don’t lose sight of your overall equity allocation.

For example, if the individual has already invested a significant amount of his money in stocks and equity funds, then he might be better off investing in a conventional pension plan from a diversification perspective.

ULIPs other important benefits like liquidity. You can withdraw money from a ULIP to meet emergencies. Also, you can invest surplus money (i.e. top-ups) over and above the premium amount.

Some insurers have launched capital guarantee ULIPs. Such products aim to guarantee the premiums paid by the individuals (net of expenses) plus the bonus declared, on maturity. Individuals, who fear ‘loss of capital’ in a ULIP, will find such products attractive.

However, capital guarantee ULIPs have lower equity exposure which could dampen returns for the aggressive investor.

‘With cover’ and ‘without cover’ plans

Pension plans are also classified as ‘with cover’ and without cover’ plans. The ‘with cover’ pension plans offer an assured life cover (i.e. sum assured) in case of an eventuality.

Under the ‘without cover’ pension plan, the corpus built till date (net of deductions like expenses and premiums unpaid) is given out to the nominees in case of an eventuality. There is no sum assured in this case.

‘Immediate annuity’ plans and ‘Deferred annuity’ plans

Pension plans are also classified as ‘immediate annuity’ plans and ‘deferred annuity’ plans. In case of immediate annuity plans, the annuity/pension commences within one year of having paid the premium (which is usually a one-time premium).

The premium paid for the immediate annuity policy is also known as the purchase price. Currently in India, very few life insurance companies offer immediate annuity plans. LIC’s Jeevan Akshay II is an example of an immediate annuity pension plan.

In case of deferred annuity, the annuity/pension does not commence immediately; it is ‘deferred’ up to a time, which is decided upon by the policyholder. For example, if an individual buys a pension plan with tenure of 30 years (also known as the ‘deferment period’), then his annuity will begin 30 years hence.

Deferred annuity premiums can be paid as a ‘single premium’ or as regular premium. Presently, most pension plans available are deferred annuity plans.

Difference between conventional life insurance plans and pension plans

There are some fundamental differences between life insurance plans and pension plans, with the objective behind both of them, being the most important. Life insurance plans aim at covering the risk from an unfortunate event. Pension plans on the other hand work on the opposite scenario that if an individual survives beyond an age (retirement age), he will need to provide for himself.

The difference in objectives is the main reason for the differences in the features of life insurance and pension plans.

Deferred annuity premiums can be paid as a ‘single premium’ or as regular premium. Presently, most pension plans available are deferred annuity plans.

Options available to individuals on pension plans

Pension plans come with various annuity options. We have explained them below:

  • Lifetime annuity without return of purchase price:

    Under this option, the individual receives pension for as long as he lives. The pension ceases on occurrence of an eventuality and the insurance contract comes to an end.

  • Annuity for life with a return of the purchase price:

    If this option is exercised, the individual receives pension till he is alive. In the event of an eventuality, the purchase price of the annuity is paid out to his nominees/beneficiaries. Purchase price here means the maturity amount, which includes the basic sum assured plus the bonuses/additions, if any.

  • Lifetime annuity guaranteed for a certain number of years:

    Under this option, the individual receives a pension for a certain number of years (as prescribed by the plan) irrespective of whether he is alive for the said period or not. A major positive of this option is that, if he survives the period, he continues to receive pension for the rest of his life.

  • Joint life/ Last survivor annuity:

    The individual receives a pension till he is alive. In case of an eventuality, his spouse receives the pension. Apart from the options mentioned above, some companies also offer both, ‘with’ and ‘without return of purchase price’. Under the ‘Joint life / last survivor annuity with return of purchase price’, in case of an eventuality to both the individual as well as his spouse, the purchase price of the annuity is ‘returned’ to the nominee.