Retirement Funds

What is a Retirement Fund plan?

• Retirement funds are commonly known as pension funds which give an individual an opportunity as an investment option to save a certain amount of their income for their retirement plan.
• This serves them as a regular source of finance after their retirement. And this amount on their investment is received until their demise.
• Retirement funds often provide a fixed benefit and they are independent of any asset return or market fluctuations.
• The investment is solely done on the investor’s behalf and income is provided as the interest, generated from the investments done earlier. This interest is generally provided on the pool of funds.
• Pension funds offer up to 11% interest depending upon the policy and investments done which makes them best suited for retirement planning. 
• Investments in Retirement Mutual Fund plans are generally done in low-risk investment options to ensure steady returns, like the government securities.

Categories

Open pension funds are custodians of at least one pension plan which has no membership restriction.

Closed pension funds are those which support pension plans that are only open to specific employees. Further classified into: Single employer funds, multi-employer funds, related member pension funds, individual pension funds.

Purpose of the fund

• The main purpose of retirement funds is to create a steady source of finance for the investor when one doesn’t have any other source of income.
• It is also considered as a financial security that provides enough capital to pay for the person’s necessities.
• There are options to receive the returns of a pension fund either as a monthly annuity or in a lump sum amount. Mostly investors go for a monthly annuity as it is paid on a fixed rate and also includes inflation protection which means that an investor receives the return adjusted to the present denomination.
• In the lump sum method, the investor is provided with the total amount of accumulated wealth once he/she retires.

How do pension funds work

Pension plans are those defined plans which means that employees will be receiving the pension payments equal to a certain percentage of their average salary paid in last few years of their employment.

In India, there are two stages of a pension plan

• The accumulation stage in which the investors pay premiums annually until the age of retirement.
• The vesting stage begins when one reaches their retirement age. In this he/she starts receiving annuities until their demise.

Where do pension funds invest?

• In the past years, these funds were limited to be only invested in government backed securities like investment grade bonds and blue-chip stocks.
• But as the market evolved, they were allowed to be invested in the majority of the asset classes.
• Nowadays, one can say that the main investment style of a pension fund is of diversification and prudence. They aim for diversification of portfolios and allocation of capital to various investment instruments like bonds, derivatives, stocks etc.
• Emerging trends have transferred many pension funds from active stock portfolio management to passive investment instruments, allocating the capital to commodities, high-yield bonds, hedge funds, and real estate as well.
• Also, private equity investments have become popular among pension funds as they are long-term investments into privately held companies. And portfolios of asset-backed securities such as credit card debt or student loans, are the new tools used to increase the overall rate of return in pension funds.

Taxability

• Any kind of contribution made in retirement funds is liable to be tax exemption up to maximum amount of Rs. 1.5 lacs (under section 80CCC).
• Whereas, if any withdrawals are done, they are tax deductible. In this case, the money is distributed as an annuity so, it’ll draw the tax depending on the existing rates.
• Similarly, to an individual’s salary being taxable, the periodic payments of pensions is also taxable according to the same policies. These taxation policies change when an individual opts for disbursement of the total amount post-retirement. Although, the ones who are the government employees are totally exempted from all the taxes.
• Non-government employees only get partial tax exemptions means till a certain amount only. One-third of the amount is exempted if gratuity is included in the pension otherwise only half of it is exempted.

Who should invest in this type of fund?

• Mutual Fund Retirement Plans are the ideal source of finance for the senior citizens as they secure assured returns for them and also carries lesser risk than other forms of investments.
• In India, there are many different types of retirement funds available. One can plan and choose according to their personal financial needs.
• An individual has a choice between the plans like one which solely invests in debt profiles as they are safer and best for a conservative borrower. Also, the person can choose unit-linked plans which invests in both equity and debt profiles, making it a bit riskier but often offers higher returns.
• The investors can also go for the third option which is of National Pension Schemes, which are the government-backed funds. In this investment is done in both debt and equity according to the investor’s preferences. Also, the investor can withdraw any percentage of the total fund and can utilise the remaining as annuity payment. Here, only the maturity amount is tax-free.

Mode of investing

• There are 2 ways to invest in the retirement funds:
• One-time lumpsum investment – This method is chosen by those investors who has a healthy cash reserve and higher risk appetite. In this one capitalises total amount at one go.
• Systematic Investment Plan – In this method, investor invests a certain sum of money every month till he/she fulfils their investment goal.
• Both of these methods have merits as well as shortcomings. Like, lumpsum investments provide higher returns but are also exposed to more risks. Whereas, SIPs are best for first-time investors as this helps them plan better for their retirement in an efficient manner.

5-STEPS to Retirement Planning:

Here are 5 simple steps which makes a retirement planning effective in the long-run for especially the young investors. They are as follows:

• List down the estimated expenses – An investor should calculate his/her expenses on the basis of its priority and also must include one’s savings and investments done till now. The current expenses indicate the future expenses which further helps to design the budget for every expense.
• Create a contingency fund – These are the emergency funds which helps planning for the unforeseen uncertain events one might not expect in future.
• Broadening the investment horizon – To create long-term wealth, the investor should go for equity investments as it has a better growth potential which can boost one’s investments. Investing into equities also helps in coping up with the inflation.
• Start investing early – Starting at early stage allows the money to get compounded for a longer period of time resulting in higher growth. For example: if X is 25 years old and has 35 years till her retirement, she needs Rs.12.5 crore as the total amount @12% in an equity fund she’ll have to pay the monthly SIP of Rs. 22,690. But if she starts investing 10 years later at 35, she’ll have to pay the SIP of Rs.73,430 at the same rate. Therefore, this shows how important it is to start early.
• Do not break it in between – One should not dig into their retirement funds in any situation. If done so, it can suffer as the balance is also taxable, if withdrawn within 5 years.

Advantages

Long-term Saving: Retirement fund plans are kind of long-term savings schemes which creates income that can be invested further in any manner.

Offers Insurance: Most of the pension policies serve as life insurance cover as they protect the insurer from any financial loss in case of their demise before retirement. The insurer can also withdraw a lump sum amount to face any medical emergency.

Flexibility: Depending upon the investor’s financial needs and plans, one can choose in what manner they want their amount either in lumpsum or monthly annuity.

Protection against inflation: Investing in pension plans offers protection for one’s assets against inflation in the form of compensation.

Risk free investment: Retirement funds have extremely low risk profile as the investors have an option to invest in either government securities or debt, equity depending upon their risk appetite.

Calculation

• For calculating the amount required for retirement one needs to evaluate several factors which directly affects their financial requirements after retirement.
• The factors to be considered are the individual’s age, possible age of retirement, life expectancy, monthly expenditure & savings, inflation, rate of return, medical expenses, assets & loans, other financial needs.
• Now to evaluate on the basis of these factors, one can use AMFI’s retirement calculator to determine the required amount.
• For example: Z is in her 30s and plan to retire after 30 years more having her annual expense as Rs. 7,20,000, she will require a corpus of Rs. 54,80,824 with 7% inflation YoY. Thus, she’d require to invest approx. Rs. 12,788 per year.

Classification of various pension plans:

• National Pension Scheme – In this scheme the investment is done in debt and equity market based on the investor’s preferences. And it allows him/her to withdraw 60% of the funds at the time of retirement and the remaining is used for the purchase of annuity. Here, the maturity amount is tax-free.
• Deferred Annuity – In this plan, one can buy the scheme through single premium or regular premium over the term of the policy and the pension begins when the policy term gets over. This plan has tax benefits as no tax is charged on the money invested until planned to withdraw.
• Pension Funds – The Pension Fund Regulatory and Development Authority (PFRDA) has authorised 6 companies as fund managers. And this plan offers better returns at the time of maturity in comparison to others and remains in force for a good period of time.
• Immediate Annuity – In this plan, as soon as the investor deposits a lump sum amount, the pension starts based on the amount invested. The premiums of this plan are exempted from tax. After the demise of policyholder, nominee is entitled to the money.
• Guaranteed Period Annuity – This annuity option has fixed periods of duration such as 5 years, 10, 15 and 20 years regardless of the survival of the investor till the duration.
• Pension Plans with and without cover – In pension plans with cover after the death of the policyholder, the family gets a lumpsum amount, which means it acts as a life cover. Whereas, without cover plan does not have life cover, thus only the nominee gets the amount after the demise. Example of with cover plan is deferred plans and for without cover is immediate annuity plans.
• Annuity certain – In this, the annuity is paid for a certain number of years and the period can be picked by the investor itself. And in case of demise the nominee receives the annuity.
• Life Annuity – This means that the annuity is paid to the person until the time of death. If dies, and had chosen ‘spouse’ as the option, then he/she receives the amount.

Comparison between Pension Plans:

Features	New Age Retirement Products (Whole Life ULIP)	Regular Retirement Product	National Pension Scheme	Public Provident Fund
100% tax-free income on retirement for life	Yes	No	No	No
Flexibility to withdraw 100% Fund Value	Yes, after 5 years	No, withdraw up to 33% of fund value upon retirement	No, partially withdraw up to 25% after 10 years	No, partially withdraw up to 50% of fund value
Tax-Free fund value withdraw	Yes, withdraw 100% value tax-free	No, withdraw up to 33% value tax-free	No, up to 60% value tax-free	Yes, withdraw 100% value tax-free
Flexibility to increase, decrease income	Yes	No	No	No
Choice of multiple investment strategies to maximize the growth of fund value	Yes	No	Yes	No
Tax exemption on amount invested	Sec 80 up to 1.5 lacs	Sec 80 up to 1.5 lacs	Sec 80 CCD (1B) up to 50K & Sec 80 up to 1.5 lacs	Sec 80C up to 1.5 lacs

Best Performing Retirement funds as per risk appetite, 2020:

Best Retirement Mutual Funds for Aggressive Investors:

• These kinds of investors fall in the age bracket of 25-40 years and are willing to invest for at least 10-15 years. They are the high-risk takers and can invest for a longer period. These funds are 100% Equity funds as they are considered as a good option for long-term investment.

For AGGRESSIVE Investors	INVEST UPTO 100% IN EQUITY
			RETURNS %
FUND NAME	NAV	NET ASSETS (Cr.)	1 YEAR	3 YEARS	5 YEARS
SBI Small Cap Fund	₹50.1034	₹3,280	-0.9	3.1	9
Sundaram Rural and Consumption Fund	₹38.79	₹1,440	-3.2	-1.6	7.6
Mirae Asset India Equity Fund	₹49.02	₹15,347	-5.2	3.7	7.7
Kotak Standard Multicap Fund	₹33.801	₹26,047	-5.4	2.4	7.2
Motilal Oswal Multicap 35 Fund	₹24.53	₹10,237	-5.5	-0.2	5.8

Best Retirement Mutual Funds for Moderate Investors:

• These funds are for investors who fall in the age bracket of 41-50 years and are willing to invest at least for 5-10 years. These are Hybrid categories which is a mix of debt and equity funds. And is a good option for those who want to earn long-term returns via equity as well as regular income via debt.

For HYBRID Investors	Equity & Debt Allocation Different for Different Funds
			RETURNS %
FUND NAME	NAV	NET ASSETS (Cr.)	1 YEAR	3 YEARS	5 YEARS
ICICI Prudential MIP 25	₹46.44	₹1,581	6.7	6.6	8.6
SBI Debt Hybrid Fund	₹42.14	₹958	5.6	3.7	6.7
Edelweiss Arbitrage Fund	₹14.75	₹3,076	5.3	6	6.1
Aditya Birla Sun Life Regular Savings Fund	₹39.21	₹1,268	-1.2	1.1	5.7

Best Retirement Mutual Funds for Conservative Investors:

• These investors are above 50 years of age who prefer investing in more conservative schemes which carries a very low level of risk. These are debt schemes offering stable returns.

For CONSERVATIVE Investors	More DEBT, Less EQUITY
			RETURNS %
FUND NAME	NAV	NET ASSETS (Cr.)	1 YEAR	3 YEARS	5 YEARS
HDFC Corporate Bond Fund	₹24.20	₹14,518	11.9	9.1	9.2
PGIM India Short Maturity Fund	₹34.62	₹33	13.9	4.2	6.2
Aditya Birla Sun Life Corporate Bond Fund	₹83.11	₹17,648	12.2	9.2	9.2
Aditya Birla Sun Life Savings Fund	₹409.49	₹12,268	8.1	7.8	8.2
Baroda Pioneer Treasury Advantage Fund	₹1,454.83	₹42	-19.7	-9.1	-2.3

Conclusion:

After getting a detailed knowledge about retirement fund/pension plans in India in the year 2020, one can say that pension fund is a must for those who’s probably going to have no source of finance once they reach their retirement phase. It is important for them to plan accordingly, understand their financial needs and estimate for the future, understand various retirement plans available in the market and make the best choice when & where to start investing into. There are various plans available according to the different requirements of the investors like risk, returns, withdrawal facilities, tax exemptions and flexibility in handling the funds. These plans are categorised for aggressive, moderate and conservative investors on the basis of the risks they’d like to go for their retirement plan. The ones who’s got big plans after they retire and planning to invest early should go for plans with higher risks and it’d provide better returns in the long-run. 

By Muskan Jain
Financial Research Analyst Intern