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.
Read: PFP Primer: Pension Plans from Insurance Companies
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.
Read: Tax Treatment of Pension Plans from Insurance Companies
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?
PersonalFinancePlan Take
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.
Read: Should you invest 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.
28 thoughts on “Retirement Planning: Pension plans or Mutual Funds?”
You have been recommending MF over NPS because of it’s various restrictions. But one compelling reason which is making me consider NPS seriously is that neither I have the time or brains to evaluate each and every MF and decide which is good for me nor I can spend hours daily doing market research.
With NPS this decision is left to experts.
Should I go in for NPS solely bcoz of ease it offers. Do you agree?
I understand your point of view. Not everyone will find selection of MF easy.
Even in NPS, you have to choose a pension fund manager.
Choice of MF is not that difficult either. You don’t have to evaluate every fund.
You don’t even have to spend hours daily. Let the fund manager do that.
Btw, You can always seek professional help.
Alternatively, simply pick up a few good funds. There is no such thing as the best mutual fund.
For instance, you can pick up a large cap fund and a debt fund. And simply maintain asset allocation through regular reviews and rebalancing.
Or simply pick up a good balanced fund and be done with it. Review fund performance annually.Do rebalancing (with a good debt fund) once you cross say 45.
I know it is easier said than done but it is not that difficult either.
Btw, NPS is not that bad either ( it is not a traditional life insurance plan). You can invest part in NPS and part in mutual funds.
NPS is also good as it maintains discipline. You cannot remove the amount being deposited for retirement. Its the cheapest also.. Its like a balanced fund, a balanced portfolio 50-30-20, a balanced portfolio should be optimum for long tenure like 30 years. whats your opinion?
Hi Deepesh
Among the different category of Debt funds like Gilt funds, Income funds, Liquid funds, short term, long term funds, Dynamic bond funds etc. which type will be suitable for safely parking the money for retirement?
Many says Liquid funds can be redeemed within a day but Escorts Liquid fund ( which gave highest return last yrs) website says it will take around 10 days. Will this change from fund to fund.
Hi Santhosh,
I prefer ultra short term and short term funds. Credit quality of underlying securities is also important.
Typically, it is 1 business day. Can’t comment about Escorts.
Thank you Deepesh
Will you also able to tell me the difference between Income funds and Dynamic bond fund
Dear Santosh,
Dynamic bond funds adjust the duration (measure of interest rate sensitivity) based on interest rate outlook.
Thank you Deepesh. And I presume Income funds don’t do that duraration adjustment.
I have seen income funds used in many contexts. Hence, I always get confused.
Don’t know what exactly you are referring to.
VRO gives long term funds under Income fund category and Dynamic bond category. Eg. BSL Treasury optimiser under Income fund and ICICI Long term fund under dynamic bond category
Thanks
Okay. For clarity about fund’s mandate, go through scheme details in the scheme information document.
You will get good clarity.
Is it good to invest in Tax Free Bonds which give an average returns of 8% per annum. Is there any investment restriction for these bonds.
You can pick up tax-free if you need regular income. There is no benefit of compounding with tax-free bonds.
There are no fresh issues in line.
So, you will have to purchase from secondary market. Even though interest rate offered in 8%, the price will be much higher than face value of say Rs 1,000 (so that yield is down to market returns).
Hi deepesh,
my currrent retirement portflio is as below;i am 30 year old
EPF 30000 per year
PPF 30000 per year
large cap equity BSL MF 2500 per month ( expecting 12% return pa)
diversified equity MF ICICI value disc.2500 per month.
i have kept asset allocation to 50:50.
Expected corpus:3 crores
My question is;
1. Are all financial product in the porfolio are good or i need to replace any product.
2.What is ideal products for retirement investment.
Please guide.
Hi Abhilash,
Can’t comment on specific investments.
For specific investment advice, you need to visit the Offerings section on the website.
I like that you are focusing on asset allocation for your retirement.
In my opinion, you can be slightly aggressive at this age, perhaps target 60:40 (equity:debt).
And yes, increase monthly investments as your salary increases.
Good luck!!!
Thanks deepesh!
but whatever combination i have choosed is ok? i.e mutual funds +PPF+EPF as a part of portfolio or is there any better option for retirement portfolio?
Thanks for reply.
About the combination, Equity MF+ PPF + EPF is a good choice.
thanks
Dear Sir,
I want to invest in NPS but the bank RM is suggesting to invest in ICICI or HDFC pension product .
So please advice me is NPS is best option to invest rather tahn private company’s Pension product
Regards
Hi Sandip,
Difficult to comment without looking into exact plans.
However, if the choice is between NPS and pension plans from private companies, NPS is likely to be a much better product.
Quick tip: Never purchase what Bank RMs sell.
Dear Deepesh,
Could u pls comment on MetLife Retirement Saving Plan?
Pay 5 lakhs premium for 5 years. Then wait for 5 more years. Total 5+5=10 years
Corpus amount at vesting 4450000. Annuity with ROP of 23300.
Or is there any similar product?
Thank you for ur time.
Joseph
Dear Joseph,
Don’t have the bandwidth to research specific products.
Suggest you contact your financial adviser.
These products can be structured in any manner.
It is a traditional life insurance plan.
But yes, I am not too fond of such products. Better to stay away.
Hi Raghaw ji,
Greetings
I am govt employee with a NPS contribution of 7000+7000(empyee+emplyr)
I have completed 40 years of age.
I am thinking of some Mutual Fund investement or some pension plan or a PPF what is a good suggestion for me will be…
Hi Teja,
Difficult to comment. I do not know anything about you.
Suggest you talk to an investment adviser.
Hi Deepesh,
I am new to SIP and I am planing to invest 20K per month as SIP. I have selected the below funds and planning to allocate as follows, I am not sure whether holding multiple fund is a healthy approach.
HDFC Balanced Fund(G) – 2000
ICICI Pru Balanced Fund(G) – 2000
Aditya Birla SL Advantage Fund(G) – 2000
ICICI Prudential Value Discovery Fund – 500
SBI Magnum Multicap Fund (G) – 2000
L&T India Value Fund – 1100
Aditya Birla SL Small & Midcap Fund(G) – 2400
Mirae Asset Emerging Bluechip-Reg(G) – 4000
Tata Equity P/E Fund(G) – 2000
L&T Emerging Business Fund – 2000
Could you please suggest.
Thanks & Regards,
Anurag
Hi Anurag,
Difficult to comment just looking at the funds. Suggest you work with a local advisor.
You have too many funds.
Hi Deepesh
You have not mentioned about benefit in NPS through company contribution ie upto max 10% of Basic and DA. It gives wider benefit and should be recognised when you compare NPS with MF. What do you think ?
Regards
Madhujit Ghose
Hi Madhujit,
Thanks for your inputs. You are right. NPS has many tax benefits.
Many aspects here. Not possible to discuss in a comment.
If the employer mandates it, there is no choice. Therefore, no need to break head over it.
Otherwise, you get the same benefit in EPF too.
At the product level, if we ignore tax benefits, mutual funds offer greater flexibility. However, this flexibility can be detrimental to many.
you need to see what works for you the best.