Think of pension and the word invokes images of an ageing government employee receiving monthly installments.
If this is how you perceive pension schemes then it's time to rework your thinking.
Insurance sector's foray has transformed the business of pension schemes by making it accessible to a large section hitherto untapped.
Pension schemes are distinct from other savings because of the difference in objective, i.e. retirement planning.
Pension plans purport to provide for an individual at a stage when he/she is presumed to be inept of earning his/her livelihood. Hence the savings need to be planned, managed and executed with an extra degree of caution.
The mechanism for pension plan is fairly simple wherein the holder makes payments either on a lump sum or installment basis to form a corpus.
The insurance company on retirement (generally 50 years) provides a lump sum, which includes the sum assured and bonuses. This lump sum amount can (subject to the prevailing rules) be partly withdrawn and the balance can be converted to an annuity at a rate offered by the insurance company.
Let us take an example to better understand the workings. Say Mr X who is 35 years old opts for a pension plan with a 20-year term and a sum assured of Rs 250,000.
This is what a pension plan offered by a life insurance company would look like.
Pension plan for Mr. X
| Particulars | Rate | Amount (Rs) |
| Sum Assured | 250,000 | |
| Expected Bonus | 4% | 200,000 |
| Expected Terminal Bonus | 20% | 50,000 |
| Purchase Price | 500,000 |
For Mr X the plan listed above would entail an annual premium of Rs 10,593. The insurance company provides annuity payments as a percentage of the purchase price.
Assuming annuity payments are offered at 6 per cent per annum the yearly pension will amount to Rs 30,000 (Rs 500,000 x 6 per cent) or about Rs 2,500 per month.
Mr X will continue to receive these annuities during his entire lifetime; while his designated nominee can receive the purchase price on his demise.
Tax concessions
Contributions to pension schemes are deductible under section 80CCC from the gross total income up to Rs 10,000. However the pension receipts are fully taxable as 'income from other sources.'
Pension schemes offer further concessions on account of tax-deferred compounding.
Contributions made over a period of time accumulate, earn interest and the sum grows; yet no taxes are levied since the payout takes place only after the retirement age.
Hence during the term of the policy the pension schemes offer additional tax benefits in an indirect manner.
Now a word of caution for pension fund investors. While pension plans clearly look like an attractive choice for your retirement needs, there is another aspect that needs to be given due attention - the fine print.
The policy document generally contains an unending list of clauses, terms and conditions that tend to be overlooked. This fine print can have a significant bearing on the returns your pension plan will generate.
Following are some of the areas investors should examine:
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Bonus calculation
Insurance companies differ in their method of computing bonus. Bonus can derived either as a percentage of the premium or as a percentage of the sum assured.
| Particulars | Policy A | Policy B |
| Sum Assured | 100,000 | 100,000 |
| Annual Premium | 10,000 | 10,000 |
| Bonus | 5,000 | 500 |
In the above case although both the companies have offered a 5 per cent bonus on policies with similar sum assured and annual premium, the quantum is better in case of policy A as the return is a percentage of the sum assured vis-à-vis policy B where the bonus is a percentage of the premium paid.
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Corpus on retirement
The corpus amount provided by the pension plan on retirement is a function of the premiums paid by policy holders during the entire term.
| Particulars | Policy A | Policy B |
| Premium | 10,000 | 10,000 |
| Life Cover premium | 500 | NIL |
| Disability Rider premium | 300 | NIL |
| Expenses of the firm | 1,000 | 1,000 |
| Balance Amount | 8,200 | 9,000 |
Opting for additional benefits like disability rider, life cover etc. reduces the amount available for investment. Clearly the policy B is better equipped to offer higher returns. If the individual is adequately covered for insurance then a regular pension plan would be the right choice.
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Plan management
The policy holder should be aware of the provisions regarding the management of his funds. Some insurance companies allow the policy holder to choose a different insurance company to manage his plan beyond the vesting period.
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Compounding returns
Insurance companies make their policies look attractive by declaring compounded returns. However companies negate these compounded returns by various means like not declaring any bonus for the first 5 years of the policy.
One can safely work out that these 'compounded' returns are barely as attractive as they claim to be.
What sets pension plans apart from other investment avenues is the freedom to choose your lifestyle post-retirement. Premiums planned and paid during the term period provide for during retirement and beyond. This is where pension plans have an edge over other comparable schemes like Post Office Monthly Income Plans
Start planning for retirement early and pick the plan that best suits your desired lifestyle. Ensuring an ideal retirement has never been easier.
This article forms a part of Money Simplified -- Asset Allocation for Tax Saving Instruments, a free-to-download online guide from Personalfn. To download the entire guide click here.
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