We tend to think about investing with a horizon of no more than three to five years. But retirement planning is about the long haul. Unfortunately, most people wake up to the reality of retirement when it is almost too late.

A small start begun early in your working life pays rich rewards later on. Here’s an example. If you invest 1 lakh every year for 30 years at a fixed rate of 8%, you will accumulate 1.13 crore. However, if you start 10 years later, you need to save more than double the amount, around 2.47 lakh a year, to be able to accumulate the same corpus.

The logic here is simple: start late and settle for less. So, the key to investing for long-term goals such as retirement is to start early—you will always be older tomorrow.

The first quarter of a financial year is a good time to plan ahead. Mint Money brings you four popular products for retirement planning and also how to choose from among these.

EPF

If you are a salaried individual, you will know the Employees’ Provident Fund (EPF) well. For those who earn more than 15,000 a month, the EPF is a voluntary scheme, but most employers don’t offer the choice to opt out.

“EPF is a statutory benefit and companies with more than 20 employees necessarily need to offer EPF under most circumstances. Administratively, it is easier for employers not to offer an opt-out choice, which would typically include only a small percentage of the total employee population," said Chitra Jayasimha, senior actuary and practice leader, Aon Hewitt, a human resources firm.

Every month, a salaried individual contributes 12% of her salary to the EPF account and the employer matches the contribution. The contributions made to EPF then compound at a rate declared by the Employees’ Provident Fund Organisation (EPFO) every year. Currently, the rate is 8.8% per annum.

Employee contribution up to 1.5 lakh qualifies for a tax deduction under section 80C of the Income-tax Act, 1961. If you withdraw the corpus after five or more years of continuous service, the corpus is tax-free.

For a salaried individual, EPF is the first product to factor in for retirement planning. Maximise your EPF contribution to get the full benefit of the tax break as well as a tax-friendly retirement corpus. Avoid dipping into this kitty as you go along your career journey.

NPS

The National Pension System (NPS) is a defined contribution product that needs you to keep contributing till 60 years of age. The minimum contribution to the scheme is 6,000 in a year.

The instrument currently offers three investment funds: government securities fund, fixed-income instruments other than government securities fund, and equity fund. The equity exposure for the private sector is capped at 50%. At 60 years of age, you need to annuitise at least 40% of the maturity corpus and the rest can be taken as lump sum.

With regards to tax treatment, the NPS has an added advantage. As per section 80CCD, 10% of your salary (gross income if you are non-salaried) that is contributed to NPS, is eligible for tax deduction up to 1.5 lakh.

You also get an extra deduction of 50,000 under section 80CCD (1b). Under the corporate NPS, where your employer contributes as well, 10% of the employer’s contribution is deductible in your hands under section 80CCD (2).

The tax changes announced in this year’s Budget have made NPS a lot more attractive. It has made 80% of the corpus (40% that gets annuitised and 40% in your hands) tax-free.

But should you put all your eggs in this basket?

“NPS doesn’t allow you the option to invest 100% in equities and for someone in her 30s or even early 40s, we recommend a higher exposure to equities to target long-term goals such as retirement, through diversified equity mutual funds. So, depending upon the asset allocation, one’s retirement portfolio should be a mix of long-term products such as EPF, NPS and mutual funds," said Nikhil Vikamsey, partner, Alpha Capital, a multi-family office. The good news is that the Pension Fund Regulatory and Development Authority (PFRDA) is planning to increase equity exposure to 75% through the lifecycle fund, which uses a predefined asset allocation. The proposal is still in the draft stage.

EPF or NPS?

Which is better of the two: EPF or NPS? The answer is, for now, both have their own utility. “Many people still draw comfort from guaranteed returns, and in that sense EPF caters to these customers, as it guarantees returns for the year. Also, given the poor level of financial literacy, EPF is a good retirement product. One cannot replace the other as both (products) have a targeted audience. There is space for both to co-exist," said Manoj Nagpal, chief executive officer, Outlook Asia Capital, a wealth management firm.

Given that EPF offers a return of 8.8% currently, it cannot be ignored completely.

“NPS is far better in terms of design, but we recommend investments through both. For those who are young and have a long-term investment horizon, looking at equity mutual funds is also recommended," said Suresh Sadagopan, founder, Ladder7 Financial Advisories, a Mumbai-based financial planner.

Equity mutual funds

Any investment for your retirement needs an equity component, and the best way to get that is using a mutual fund product. How much you need to invest will depend on your asset allocation and years left to retirement. Those with a long-term horizon of more than 10 years must go for an equity-heavy portfolio.

“Even in equity we need to look at risk tolerance levels. For someone with low tolerance, we would recommend diversified large-cap equity funds, index funds, exchange-traded funds and equity-oriented balanced funds, whereas someone with a higher threshold could look at mid-cap, small-cap and sectoral funds," said Sadagopan. Equity funds are tax-free after a holding period of one year.

Fund houses also offer pension plans, but in their current format, these products don’t cut much ice.

“They are not much different from a mutual fund except that they come with lock-ins and a heavy exit load. In comparison, NPS has a superior design. You can move from equity to debt in NPS with no tax incidence. However, NPS needs a better customer interface and stability in the thought process as the architecture is constantly undergoing changes," said Nagpal.

Insurance pension plans

Pension plans from life insurance companies also qualify for a tax deduction under the overall section 80C basket of 1.5 lakh. In addition, these plans are mandated to offer a positive return of premiums on maturity or on death of the policyholder. This means that the unit-linked pension plans (Ulips) that are market-linked and offer you various investment funds to choose from, typically do not offer pure equity funds.

To manage the guarantee requirement, the insurance company will invest a considerable amount of your money in debt instruments. On maturity, you can keep up to a third of the corpus tax-free in your hands, and the remaining needs to be annuitised or used to buy a single-premium pension plan.

However, pension plans are not recommended by financial planners. They recommend NPS instead since it is low-cost and it allows you to keep a larger portion of the maturity corpus as lump sum giving you more liquidity and flexibility.

If you have not given retirement planning any thought, now is a good time to start. But first start with getting your asset allocation in place; for your equity investments, you should primarily consider mutual funds (remember, NPS only allows 50% in equity).

For your debt investment, first factor in your EPF investments and then look at the NPS option.

Use the first quarter of this financial year to secure your long-term goals. The earlier you start, the better it will be.

Close