Aquery that we often receive at Mint Money is how to build a retirement corpus—while some plan early retirement, some plan to follow the course. Regardless of when you decide to hang up your boots, the one need you will have to service is periodic income. In order to maintain your lifestyle after retirement, one thing that you need to do is to start saving as early as possible. Another factor you must consider is to get a return kicker by not just remaining invested in debt instruments, but also looking at some market-linked investments.
In fact, some retirement products are designed in a way to accommodate debt as well as market-linked elements. Here are the options you can look at.
Mutual fund products
Mutual funds (MFs) offer two kinds of retirement products—ones that offer tax deduction and other than don’t. Let’s call schemes that offer tax deduction type I and those which do not type II schemes.
Besides the difference in tax treatment, type I and type II schemes’ investment pattern differs significantly. While type I schemes primarily invest in debt, irrespective of the age of investor, type II schemes mainly invest in equities until the time the investor nears the age of retirement. Typically, after the investor crosses 60 years of age, the fund begins to invest primarily in debt in order to secure your capital. You can make systematic or lump sum withdrawal during this stage.
There are two type I schemes in the market: Templeton India Pension Plan and UTI Retirement Benefit Fund. Both the schemes invest 40% of the corpus into equity and the balance into debt. These funds are relatively safe as a major part of the corpus is invested in debt, but they do not guarantee your capital.
Graphic by Yogesh Kumar; Illustration by Shyamal Banerjee/Mint
On the other hand, type II schemes are being offered by several MF companies, including Birla Sun Life Asset Management Co. Ltd and ICICI Prudential Asset Management Co. Ltd. The newly launched Tata Retirement Savings Fund by Tata Asset Management Ltd also falls in the same category. Since type II schemes mainly invest in equities, the long-term returns may be higher as compared with type I scheme. “In the long run, equities are likely to yield higher returns compared with any other investment class and since our scheme investments in equities are higher compared with some other MF schemes, insurance plan or even National Pension System (NPS), it suits investors looking for higher appreciation,” says Bhupinder Sethi, fund manager, Tata Retirement Savings Funds.
Also See | Why Should You Use The NPA As a Long-term Retirement Option (PDF)
Assuming the same rate of return, type 1 schemes are better because of the tax deduction factor. Sample this: you invest Rs 25,000 every year for 20 years and the scheme charges an expense ratio of 2%. At 10% per annum your corpus would be Rs 12.06 lakh. In a type 1 scheme, if you factor in the tax deduction, you will save Rs 7,725 every year assuming you are in the highest tax bracket of 30.9%. Over 20 years, this would add up to Rs 1.55 lakh.
Type 1 schemes tend to lose their edge only if the returns from equity are very high. For instance, equity funds’ yield would be higher if they return 15% as compared with type 1 funds that yield 10%. Hence, the choice between the two depends on your risk profile.
The problem: Both type I and type II schemes discussed above suffer a problem—they have an easy exit option. By paying an exit load, you can redeem your investments and this can dent your retirement savings. Says Sethi, “Ideally, only a partial withdrawal should be allowed but the Indian market would take more time to mature to that level.”
Pension products from insurance companies have a better cost structure, but owing to a mandatory guarantee on the capital, pension policies invest heavily in debt products.
Let’s sample a policy from the Life Insurance Corp. of India (LIC). LIC’s Pension Plus is a regular premium policy that offers two options—one invests up to 100% in debt, while the other limits debt exposure to 65-85%. It has a premium allocation charge of 6.75% in the first year, 4.5% from the second to fifth years and 2.5% thereafter. The fund management charge is 0.7% for the debt fund and 0.8% for the mixed fund.
Assuming a return of 10% over 20 years on an investment of Rs 25,000 every year, the policy will return Rs 13.16 lakh. Throw in the additional Rs 1.55 lakh—the premiums of pension policies qualify for a tax deduction under section 80C—and the total corpus at the end of 20 years stands at Rs 14.71 lakh.
The problem: Though pension policies have a friendlier cost structure, they may not turn out to be an effective investment vehicle over the long term. According to the guidelines of the Insurance Regulatory and Development Authority, insurance companies need to provide a minimum guaranteed return of 3-6% on the total premiums paid. To fulfil the requirement, insurance companies invest predominantly in debt and hence the returns are conservative. “Under the present structure, retirement products offered by insurance companies would not be able to provide high return. The cost structure of insurance products too is higher as compared with other products such as the NPS. Hence, even conservative investors should not invest in these products and would be better off investing in products like NPS,” says Satkam Divya, business head, Rupeetalk.com, a Net Ambit Venture.
National Pension System
Like MF and insurance products, NPS also invests in a mix of equity and debt. The scheme allows for three investment options: equity (E) in which a maximum of 50% can be invested, fixed income instruments other than government securities (c) and government securities (G).
What compensates for lower equity investment by NPS (up to 50%) is its low cost structure. Among all retirement product, NPS charges the least. The costs in NPS are a mix of fixed and variable costs. While the fixed costs fail to make any visible dent on the return, especially if the investment corpus is large, even variable costs are minimal. The fund management charge is as low as 0.0009%. Hence, your investment of Rs 25,000 per year for 20 years at an annual return of 10% per annum would give you Rs 15.45 lakh.
Also, since NPS provides tax deduction, indirect savings can yield another Rs 1.55 lakh. And it is not the cost alone that pleases you; the structure of NPS is such that it allows for no leakages. The scheme has a strict lock-in till 60 years of age. If you wish to withdraw before you turn 60, the system discourages you by annuitizing at least 80% of your corpus: it buys an annuity product that gives periodic income.
What should you do?
If you are a conservative or balanced investor, NPS is best suited for you. Type 1 MF schemes and debt-oriented pension plans are best avoided. For risk takers or equity investors, we recommend equity diversified mutual funds for wealth accumulation.