Once you retire from work, you need to replace your salary with some other sources of regular income.
You do that by deploying your retirement corpus into the right investment products. When it comes to investments, retirement comes with its own set of problems. You need to generate a regular income. Income should grow with inflation. Your investment should be reasonably liquid. And capital preservation is a high priority too.
In this post, I will list out the pros and cons of various investment products to generate regular income during retirement. Do note these are NOT strategies to generate income during retirement.
The basic premise is that you are looking for stable income during retirement. The suggestion of exact financial products during retirement is not possible without complete assessment of your risk profile, financial assets (retirement corpus), expenses etc.
You need to assess the product suitability for yourself. Seek services of a financial planner or a SEBI registered Investment Adviser if required.
1. Fixed Deposits
You can select monthly, quarterly, half-yearly or annual interest pay out options.
Pros: Easy to understand. Fixed deposits can be easily liquidated in case of emergency for a small penalty.
Cons: Interest income is taxed at the marginal income tax rate. You will not find fixed deposits for tenor greater than 7-10 years. You may get a lower interest rate when you renew your fixed deposit. TDS is applicable. However, you can submit Form 15G/H if your taxable income is less than Rs 2.5 lacs (or Rs 3 lacs or Rs 5 lacs as the case may be).
2. Senior Citizens Savings Scheme (SCSS)
Only senior citizens (>60 years) are allowed to invest in SCSS. Interest is paid out quarterly. You can open deposit for 5 years with an option to extend the deposit for another 3 years. You can open SCSS deposits in banks and post offices. Interest rates are announced by the Ministry of Finance every quarter.
Rate is 8.7% p.a. (as on April 18, 2018).
Pros: Interest rate will most likely be higher than fixed deposit with tenure of 5 years. You get tax benefit on investment in SCSS under section 80C of the Income Tax Act. Exit possible in cases of emergency at a small penalty.
Cons: Interest income is taxable. You cannot invest more than Rs 15 lacs in SCSS i.e. the principal amount invested at any point of time cannot exceed Rs 15 lacs. Even if you invest in the name of your spouse, the maximum investment in SCSS is Rs. 30 lacs combined. TDS is applicable but you can submit Form 15G/H.
3. Post-Office Monthly Income Schemes (POMIS)
These are similar to fixed deposits. Maturity period is five years. Interest is paid out every month.
Interest rate is announced by Ministry of Finance every quarter. Rate is 7.7% p.a. (as on April 18, 2018).
Pros: Easy to understand. No TDS applicable. There is no tax benefit on investment. You can exit the investment at a small penalty. Premature withdrawal attracts a penalty of 2% if withdrawn within 3 years and 1% thereafter.
Cons: You can invest a maximum of Rs 4.5 lacs in a single account or Rs 9 lacs in a joint account. Your total share of investment in POMIS cannot exceed Rs 4.5 lacs. Interest is taxable.
4. Tax-Free Bonds
You can purchase tax-free bonds with maturity up to 20 years. You can purchase tax-free bonds from the secondary market too.
Pros: Interest income is exempt from tax. These bonds are suitable for investors in the highest income tax bracket. Such bonds are issued by PSUs. Hence, there is little risk of default. You can lock-in tax-free interest rate for a long term.
Cons: Issues are few and far between and decision to grant tax-free status lies with the Government. Demand is high and you may not get the desired allocation. Liquidity is not high in every issue. In case of emergency, you may have to exit at an unfavorable price. Moreover, there is price risk. If the interest rates have inched up since your purchase, you will have to sell at a loss (if you want to exit in the secondary market).
5. Annuity Plans
Do not confuse annuity plans with Pension plans. Under Pension plans, there is an accumulation phase followed by distribution phase (purchase of annuity plan). Under an annuity plan, you pay a lump sum amount to an insurance company and the insurance company regular income for life.
For instance, NPS is a pension plan. Under NPs, you keep making contribution till retirement. At the time of retirement, you use the accumulated corpus to purchase an annuity plan.
Pros: Insurance companies bear the interest rate risk. You are guaranteed a fixed income for life. Annuity plans are available in multiple variants. One variant provides income to the spouse after your demise. If you select variant without return of purchase price, the return can be quite high.
Cons: Annuity rates are quite low. It is not too difficult to replicate the performance of an annuity plan on your own. Annuity income is taxed in the year of receipt.
6. Rental Income
The entry barrier is high. You need to have enough money to purchase a house outright. Banks are unlikely to offer home loans to retirees. Hence, you need to have planned for this well before your retirement.
Pros: There is scope for capital appreciation too. Many of you may be comfortable with the house on rent. Rent typically increases with inflation and that is a tacit understanding between tenants and owners.
Cons: Rental yields are low in India. You will be fortunate to get a rental yield of more than 2-3% p.a. However, this is when you purchase the house today and put it on rent. Had you purchased the house many years earlier, yields may be much higher. Rental income is taxed (after a few deductions).
7. Debt Mutual Funds
You are better off with low duration funds i.e. liquid, ultra-short term, short term. The advantage debt funds have over fixed deposits is that the redemption in debt mutual is more tax-efficient at least for units held for over 3 years.
You can opt for the dividend option. However, the timing of distribution of dividends and its quantum is in the hands of the fund manager. As per regulations, the dividend can only be distributed from surpluses. Thus, in periods of bad performance, the ability to distribute dividends may go down.
Though dividend is tax-free in the hands of the investor, the mutual fund house (AMC) pays dividend distribution tax at the rate of 28.325% in case of debt mutual funds.
Hence, dividend option may not even be tax-efficient for investors in 10% and 20% income tax bracket. You may be better off investing in growth option and setting up a Systematic withdrawal plan.
Pros: Debt MFs can more tax-efficient. Typically, there is no penalty for exiting from liquid, ultra short term, and short term debt funds.
Cons: The returns are not guaranteed. There is market and credit risk. In a rising interest rate environment, you may even suffer capital losses. The risk is higher for long duration debt funds. Debt funds come in multiple variants. It is easy to get confused and pick up a wrong debt fund.
8. Monthly Income Plans (MIP) from Mutual Funds
The name is a misnomer. There is no guarantee of regular income of monthly income plans from mutual funds. Income is distributed in the form of dividends. Fortunately, they can’t use the same nomenclature anymore.
These plans are hybrid plans and take a small exposure to equity too. Typically, the equity exposure is limited to 15-20%. This means MIPs are considered as debt funds from the point of view of taxation.
As discussed in the previous point, choosing growth option and setting up a Systematic Withdrawal plan (SWP) may be better than the choosing Dividend option.
Pros: There is small exposure to equity which provides scope for higher returns.
Cons: You do not control the distribution of dividends. Quantum and timing of dividend distribution is at the discretion of the fund manager. Equity portion is anyways high risk. Regular income is not guaranteed.
9. Corporate Fixed Deposits/Non-Convertible Debentures
These are fixed deposits issued by companies and non-banking finance companies. You need to sure of credit quality before investing in these instruments.
Pros: Interest rates may be higher than bank fixed deposits.
Cons: Many companies indulge in smart marketing. Actual return is much lower. All kinds of companies issue such deposits. You need to do research before investing in these instruments.
10. Reverse Mortgage Loans
This is to be used in dire circumstances. For more on reverse mortgage loans, go through the following post.
11. Pradhan Mantri Vaya Vandana Yojana (PMVVY)
Only senior citizens can invest. You can invest a maximum of Rs 15 lacs per person. You can lock-in the rate of interest for 10 years. The current interest rate on PMVVY is 8%. For more on PMVVY, please refer to this post.
Points to Consider
- Inflation and poor health can be your biggest enemies during retirement.
- Not only do you need to generate regular income, but the income should also increase with inflation
- In this post, I have highlighted only ways to generate income during retirement. Inflation-adjusted income needs to be generated through a retirement strategy. For instance, you could use a bucketing strategy where you put funds needed in next 10 years in debt instruments and funds needed after 10 years in debt oriented hybrid funds and the funds needed after 15 years in balanced funds. More on this in another post.
- In old age, you cannot just focus on high returns. You need to look at comfort too. An 80-year old person may find it difficult to visit the bank branch to renew fixed deposits or manage investment corpus on a regular basis. He/she cannot be expected to keep visiting the registrar office to sign leave and license agreements (for rent). Same applies to anyone who has a physical limitation. In that case, you may be better off investing in an annuity plan. It is another matter that annuity rates increase with age.
- Though I have discussed primarily debt products, it does not mean you should completely shun equity investments during retirements. A small exposure to equity investments will help you counter inflation during retirement.
- Tax treatment of investments may also influence your choice of investment.
This is no way a holistic list. Do leave your inputs in the comments section.
The post was first published in May 2016 and has been updated since.