BackCommuting your pension money
The returns from your NPS or pension don't have to go totally towards an annuity planwhich gives you a regular income after retirement. There are provisions for commuting it, to get lump sums. Here is how you do it
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When you invest for your retirement through products such as the National Pension System (NPS) or a pension plan offered by life insurance companies, the product construct is such that at the end of the investment period—on your retirement—you take the accumulated corpus to buy an annuity. An annuity is a pension product that pays you regular income for life.
But what if at the time of retirement you need a lump sum? The good news is that these products allow you to take a portion of the accumulated money as lump sum. In financial parlance, this is called commuting. It basically means an upfront payment of your pension money.
Let’s understand the commuting provisions in the NPS and pension policies offered by life insurance companies.
NPS is a defined contribution retirement product that needs you to stay invested till 60 years of age. It’s a market-linked product that offers four investment options: scheme G invests in government securities, scheme C in fixed-income instruments other than government securities, scheme E in equities (limited to 50% or 75% through the lifecycle fund) and scheme A in alternate investment funds (limited to 5%). Early withdrawals are discouraged and you can keep only 20% of the money and have to buy an annuity with the remaining 80%. However, partial withdrawals are allowed for certain events.
At 60 you can withdraw, or what is also called commute, up to 60% of the money (40% is tax free and 20% taxable). With the remaining 40% you need to buy an annuity. While you don’t pay any tax on the amount earmarked for buying an annuity, the annuity income (pension) that comes your way is taxable.
Life insurance companies offer pension plans that can broadly be divided into two categories: traditional pension plans and unit-linked pension plans (ULPP). Traditional plans don’t disclose investment portfolios or costs. They either offer a minimum guaranteed return and peg additional returns to bonuses, or offer a guaranteed benefit at the very outset. ULPPs, on the other hand, are market-linked products in which you can see the costs as well as the fund performance.
ULPPs come with a lock-in of 5 years, whereas in the case of traditional plans there are heavy surrender penalties—meant to discourage premature withdrawal. As per rules, a pension plan by a life insurance company needs to offer a non-zero positive return of premiums to the policyholder on maturity.
On maturity you can commute one-third of the accumulated amount and annuitize the rest. The lump sum in your hands is tax-free. However the annuity income is taxable. The other option is to use the money and buy a single premium pension plan again, but on maturity you will still need to annuitize the minimum amount.
Even as pension plans allow you to commute a part of your accumulated corpus to meet immediate requirements, financial planners don’t like the compulsory annuitization of pension money. This is so because, the minute you invest in these plans, you get committed to buying an annuity product several years down the line on retirement.
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