Plan to start saving for your retirement? Where should you invest?
Let’s look at various products where you can invest in.
- Defined Benefit Plans from Employers
- Pension plans from Insurance Companies
- National Pension Scheme (NPS)
- Retirement Plans from Mutual Funds
- Disciplined investing in Mutual funds (along with PPF, EPF etc)
In this post, I will compare pension plans from insurance companies and disciplined investments in mutual funds.
Where Pension plans from Insurance Companies are better?
- Easy to Understand: Very simple to understand. You contribute for a few years and then you get regular income at the time of retirement (or plan maturity). Investment period and maturity is clearly defined. By the way, this can be a mistake. Pension plans come in many variants. You must understand the product properly before deciding to invest.
- Investment Discipline: You pay annual premium every year. You don’t have much choice. Thus, it is easier to stick to investment discipline.
- Tax Benefit on Investment: You get tax benefit of up to Rs 1.5 lacs for investment in pension plans under Section 80CCC of the Income Tax Act. Only select equity mutual funds (ELSS) are eligible for tax benefit under Section 80C.
- Tax Benefit on Debt portion: With pension plans, a portion of your investment gets invested in debt portion too. With some plans, the entire amount gets invested in debt instruments. Hence, in pension plans, even investment in debt enjoys tax benefits. Moreover, investment in debt mutual funds is just not eligible for tax benefit.
Note: Total tax benefit under Section 80C, Section 80CCC and Section 80CCD(1) cannot exceed Rs 1.5 lacs in a financial year. Benefit of Rs 50,000 for NPS investment under Section 80CCD(1B) is extra.
Where Mutual Funds are better?
- Flexibility at Maturity: There is no mandatory purchase of annuity. You can always purchase annuity if you wish and if it is beneficial because of old age or health issues. In case of pension plans from insurance companies, there is no choice. At least 2/3rd of the maturity amount (at least 40% in NPS) must be used to purchase annuity plans. There is no choice. Annuity rates are low in India. And it is NOT very difficult to replicate performance of annuity plans on your own.
- Taxation of Income: Annuity income is taxed in the year of receipt. With pension plans from insurance companies, purchase of annuity is a must. With mutual fund investments, you can withdraw as and when you want (through Systematic Withdrawals Plans or any other manner). Rules of taxation for capital gains on equity and debt mutual funds shall apply. With equity and balanced funds, long term capital gains are exempt from tax. With debt funds, long term capitals gain are taxed at 20% less indexation.
- No surrender cost or restrictions on exit: With mutual funds, there is no restriction on exit. You can exit if needed without any penalty. Exit load is only for a few years. With pension plans, cost of surrender is quite high. Moreover, the entire surrender value gets taxed in the year of surrender, which can result in huge tax liability.
- Better control over investments: You can choose your asset allocation on your own with MF investments. With pension plans, you may NOT always have that choice. By the way, better control over investments may not be a good thing for everyone.
There is no need to limit yourself to Mutual Funds
You are not just limited to mutual funds if you are building a corpus for your retirement. You can invest in PPF or EPF (voluntary contributions) or any other instrument too.
It is not always wise to keep your entire retirement corpus in equity funds. You will need to keep some portion in debt too.
One of the aspects that went against mutual funds was that there were no tax benefits for investing in debt mutual funds for retirement. However, you could have invested your debt portion in PPF or EPF too and got tax benefits for such investment.
Must Read: How to use PPF as a pension tool?
I prefer mutual funds over pension plans. There is far greater flexibility.
Many of us get sold to the nomenclature of a financial product rather than its features. Since pension plans (or retirement plans) have pension or retirement written over it, it is easy to fall for such plans. It is better to resist such temptation.
You may be better off investing in equity mutual funds early on and gradually shift investments to debt funds as you move closer to retirement. Post retirement, if you wish, you can always purchase annuity with the corpus.
However, investing in mutual funds requires much greater discipline than investing in a pension plan. Hence, if struggle on the discipline front, it is better you stick to pension plans. Something is better than nothing. Choose ULPP over traditional pension plans in that case.
Why I picked only Pension plans and Mutual Funds for comparison?
I did not consider defined benefit plans from employers because such pension plans are not subject matter of choice. Either your employer offers it or does not offer it.
I had written about retirement plans from mutual funds and compared such plans against pension plans from insurance companies and NPS in an earlier post. In any case, there is not much interest in Retirement plans from mutual funds.
I have written about NPS in many posts before. Hence, I did not cover NPS in this post. In my opinion, NPS is better than pension plans from insurance companies. When it comes to comparison with mutual funds, I still prefer mutual funds. For some of us, additional tax benefit under NPS under Section 80CCD(1B) may tilt the balance in favor of NPS. Do note it is NOT an either-or decision.
The post was originally published on June 7, 2016.
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