PFP Primer: Pension plans from Insurance Companies

For many of us, retirement planning is all about creating an income stream during retirement. Pension products can do that for you. There are quite a few retirement plans available in the market.  Pension plans from insurance companies corner a fair share of this market. In this post, I will discuss pension plans from insurance companies in detail.

How does a Pension Plan work?

A pension plan can be divided into two phases viz. accumulation and distribution.

1. Accumulation Phase: You invest regularly in the pension plan over the working years. The pension keeps growing over a period of time. The choice of pension plan will decide how your contributions get invested.
2. Distribution Phase: After retirement or at pension plan maturity, you use full or a portion of accumulated corpus to purchase an annuity plan. Under an annuity plan, you make a lump sum investment in the annuity plan and the insurance company makes monthly (or periodic) payments for life or for a fixed period.

It is not necessary that you purchase annuity only at the time of retirement. Depending on the terms and conditions of the insurance plan, you can start drawing pension income at an earlier or a later age.

In this post, I will focus on proper pension plans where accumulation phase is followed by purchase of annuity (distribution phase). Some of us might confuse pension pans with annuity plans. An annuity plan is purchase of an income stream from an insurance company.

A minor Digression: Types of Annuity plans

This is just to avoid any confusion about usage of terminology in this post.

1. Immediate Annuity: As soon as you purchase the plan, the pension starts. Hence, there is no accumulation phase. You hand over a sum to the insurance company and the insurance company starts paying you monthly (or periodic income). LIC Jeevan Akshay VI is an immediate annuity plan. Common immediate annuity plans are:
   1. Annuity for life without the return of purchase price
   2. Annuity for life with return of purchase price
   3. Annuity for life and thereafter to spouse till his/her death (without return of purchase price)
   4. Annuity for life and thereafter to spouse till his/her death (with return of purchase price)
   5. Annuity for life increasing at a certain rate

Please understand an annuity product is merely a contract and can be structured in any way subject to extant regulations. Hence, there can be many more variants and many more permutations and combinations.

2. Deferred Annuity: You keep investing in a pension plan and the payout starts after a specific period (or after retirement). At the time of retirement, you use the full or part accumulated corpus to purchase an immediate annuity plan. Hence, there is an accumulation phase followed by a distribution phase.  Under deferred annuity plans, you go through an accumulation phase and subsequently purchase an immediate annuity (at the prevailing annuity rates).  LIC Jeevan Nidhi is a deferred annuity plan.

When I refer to Pension Plans in this post, I am referring to the plans that have an accumulation phase followed by an annuity purchase (withdrawal phases). 

When I refer to annuity, I am referring to immediate annuity plans. 

By the way, even this nomenclature can be confusing, LIC Jeevan Shanti has both immediate annuity and deferred annuity variants. However, even for the deferred annuity variant, it guarantees the income (whenever it starts).

Different Types of Pension Plans issued by Insurance Companies

There are two broad classifications.

1. Endowment/Traditional Pension plans: During the accumulation phase, your money will be invested in primarily debt securities. Like traditional life insurance plans, the cost structure of these plans is not very transparent.
2. Unit-linked pension plans (ULPPs): Your money gets invested in both equity and debt instruments. You can choose allocation based on your preference.

Within the aforesaid major classification, you can have multiple variants.

You can have single premium plans, regular premium payment plans, limited premium payment plans.

Premium payment term is the number of years for which you will pay premium.

Policy term is essentially the difference between your current age and vesting age (maturity). At maturity, you will use the accumulated corpus to purchase annuity.

Depending upon the type of plan, the premium payment term may be equal or less than the policy term.

Though the pension plan can be structured in many different ways, every pension product needs to adhere to guidelines for pension products laid down by IRDA, the insurance regulator.

IRDA Rules for Pension Plans from Insurance Companies

I am listing down some of the important regulations:

All pension plans must have defined Assured Benefit that is applicable on death, surrender or vesting (maturity). Assured Benefit means either the guarantee of a non-zero positive return on all the premiums paid OR a guaranteed amount payable at the time of maturity, surrender or death of the policy holder.

Unit Linked Pension Plans (ULPPs) have a lock-in of 5 years. You can surrender the policy if you want to before completion of 5 years. However, your money will remain invested till the end of 5^th year.

On Surrender of pension plan, after the lock-in period (if any)

1. You can withdraw only up to 1/3^rd of the accumulated corpus. Remaining 2/3^rd needs to be utilized to purchase an immediate annuity product. OR
2. Alternatively, you can use the entire proceeds to purchase a deferred pension product.

At the time of vesting (Maturity)

1. You can withdraw up to 1/3^rd of the accumulated corpus. Remaining 2/3^rd to be used to purchase of immediate annuity product. OR
2. Use the entire corpus to purchase a deferred pension product. OR
3. Extend the period of accumulation in the same policy, provided the age of the policyholder is less than 55 years.

In case of death during the term of the pension plan

1. Your nominee can use the entire proceeds to purchase the annuity plan. OR
2. Your nominee can withdraw the entire proceeds as lump sum.

Tax Treatment of Pension Plans

I have covered this aspect in detail in one of my earlier posts.

Read: Tax Treatment of Pension Plans from Insurance Companies

Examples of Pension Plans from Insurance Companies

HDFC Life Assured Pension Plan (A Unit Linked Pension Plan)

You can read the product brochure here.

1. Minimum Entry Age: 18, Maximum Entry Age: 45
2. Minimum Vesting Age: 45, Maximum Vesting Age: 75
3. Premium Payment Term: Single Premium, 8, 10 and 15 years
4. Policy Term: 10, 15 and 35 years
5. No liquidity in first 5 years. Even if you discontinue the plan before 5 years, you cannot exit the plans. Your contributions remain invested till the end of 5^th
6. Assured Benefit on Death = Higher of (Fund Value, 105% of premiums paid till date)
7. Assured Benefit on Surrender= Fund Value
8. Assured Benefit on Vesting= Higher of (Fund Value, 101% + 1%*(Policy Term – Premium Payment Term)*Total Premiums Paid)
9. Premium Allocation Charge = 3.9%-5% of annual premium
10. Fund Management Charge = 1.35% of the Fund Value
11. Investment Guarantee Charge = 0.5% of the Fund Value
12. Two funds available: Equity Plus Fund and Income Fund
13. Equity Plus Fund has 80% to 100% equity exposure
14. Income Fund has 100% debt exposure
15. Allocation between Equity Plus and Income Fund decided is automatically based on policy term, premium payment term and the policy year. The investor has no choice.
16. Benefits merely mean the value of the accumulated pension corpus. It does not mean you can take out the proceeds as you wish. Utilization of policy proceeds (at the time of vesting, surrender or death) shall be as per IRDA regulations mentioned above.

HDFC Life Guaranteed Pension Plan (Traditional Non-Participating Pension Plan)

The less I speak about the plan, the better.  There is no reason anyone should purchase a traditional pension plan. It is very much similar to a traditional life insurance plan.  Opaque cost structure, heavy surrender penalty and guaranteed low returns. Hallmark of a traditional life insurance plan. Just that a few restrictions have been placed on the utilization of policy proceeds since it is a pension plan.

I wouldn’t go into details of the plan.

You can read the product brochure here.

Which one is better? ULPP or Traditional Pension Plans

Beyond a doubt, a Unit Linked Pension Plan is far better than traditional pension plans.

However, that does not mean you must invest in Unit Linked Pension Plans.  Even with ULPP, the cost structure, at least for this plan, is quite high. Additionally, there is mandatory purchase of annuity for 2/3^rd of the accumulated corpus.  Tax treatment at maturity is not too great either. Annuity income gets taxed at marginal income tax rate.

Unlike NPS, there are no special tax benefits for investing in these pension plans.

Compounding the woes,  the annuity rates are quite low. It is not too difficult to replicate performance of an annuity plan.

If you have enough discipline, you can create retirement corpus on your own by investing in mutual funds, PPF, EPF etc. Do note the big If. There will be no mandatory purchase of annuity. You can withdraw funds from retirement corpus based on your requirement and in a better tax efficient way. You always have the freedom of purchasing an annuity plan if you need.

Additional Read: How to use PPF account as a Pension tool?

In my opinion, you must not invest in pension products from insurance companies. Accumulate retirement corpus on own. Purchase annuity plan subsequently if you must purchase one.

Image Credit: Simon Cunningham, 2014. The original image and information about usage rights can be downloaded from Flickr/LendingMemo.