Once popular, now forgotten, pension plans offered by life insurance companies may become attractive once again if the latest product regulation draft by the Insurance Regulatory and Development Authority of India (Irdai) is implemented. The draft makes the design of unit-linked pension plans (ULPPs) more flexible and puts it squarely in competition with the National Pension System (NPS). But an important drawback remains: ULPPs continue to be more expensive than NPS. We tell you how the two compare.
On product structure
ULPPs are much like unit-linked insurance plans (Ulips), except that they do not offer insurance currently. Your money gets invested in the funds of your choice and just like Ulips, ULPPs come with a lock-in of five years.
The similarity with Ulips ends here though. Being a pension plan, ULPPs’ product construct discourages early withdrawals. They don’t allow partial withdrawals and if you choose to liquidate your investments before the policy term, you can only keep one-third of the money. The balance needs to be annuitised on withdrawal, (an annuity product pays regular income). Or, you can use the balance to buy a single-premium pension policy. Even on maturity, you can keep only one-third of the corpus; the rest needs to be annuitised.
In NPS, you need to contribute a minimum sum every year and it doesn’t allow you to liquidate all your money before turning 60 years old. If you do, it annuitises 90% of the corpus, allowing only 10% to be taken as lump sum.
But it allows partial withdrawals. After staying invested for about three years, you can withdraw up to 25% of your contribution for emergencies such as child’s education, marriage, buying a house or treatment of a critical illness ailment. You can make up to three partial withdrawals during the tenure and this puts NPS a notch above ULPPs. At the time of maturity, when you are 60 years of age, you can keep up to 60% of the accumulated corpus and annuitise the rest. In ULPPs, you can only pocket 33.33% of the corpus.
The draft on ULPPs proposes to increase withdrawable corpus to 60% and allow partial withdrawals after the lock-in period, which will make ULPPs similar to NPS.
On investment pattern
ULPPs don’t offer pure equity funds because they are currently mandated to offer a minimum non-zero positive return on the investment, on maturity or on death of the policyholder. In NPS, you can invest up to 75% in equity. But this story is set to change for both.
The draft on ULPPs mandates capital guarantee only on death and not on maturity; this will allow insurance companies to offer more aggressive funds. “The draft has made it optional to offer capital guarantee on maturity which would enable customers to invest in more aggressive funds which is ideal for building corpus over a long term," said Manik Nangia, director marketing and chief digital officer, Max Life Insurance Co. Ltd.
In case of NPS too, as per the G.N. Bajpai Committee report, a 100% allocation to equities is recommended, and PFRDA has already increased the equity allocation from 50% to 75%.
Cost is the significant differentiator between the two. NPS can charge only 0.01% as investment management fee—this may undergo some revision in the near future—whereas ULPPs come with a fund management charge of up to 1.35% and distribution costs of 7.5% of the premium in the first year and 2% subsequently. Under NPS, the distribution fee is capped at 0.25% of the contributions to a maximum of ₹ 25,000.
After factoring other sundry costs in both products as well, NPS emerges the winner. For example, as per the benefit illustration of an online ULPP, where the only costs are fund management cost and charge of capital guarantee, at an 8% growth rate, an annual investment of ₹ 1 lakh for 15 years will return around ₹ 24 lakh. At the same rate of return and equal investment, NPS would return around ₹ 29 lakh.
Which is better?
In terms of cost and flexibility, NPS emerges the clear winner and now it also has a tax advantage. “(In NPS), you get an extra deduction of ₹ 50,000 under Section 80C and now the 60% corpus that one can withdraw is also tax-exempt. In fact, you also don’t pay any GST (goods and services tax) when you buy an annuity product through NPS whereas you pay a GST of 1.8% of the corpus when you buy annuity through a pension plan," said Sumit Shukla, chief executive officer, HDFC Pension Management Co. Ltd.
In case of ULPPs, you are currently allowed to withdraw up to 33.33% of the corpus tax-free. However, according to C.L. Baradhwaj, executive vice-president (legal and compliance) and company secretary, Future Generali India Life Insurance Co. Ltd, if the draft proposal is implemented, even 60% of the corpus will be tax-exempt. “Income tax exempts the entire commutable corpus under Irdai-approved pension policy," he said.
NPS continues to score due to low costs which over the long term can magnify into a huge advantage, but financial planners advice caution. “The annuity income remains taxable and under both the products, 40% has to be annuitised. This is not suitable for a retired individual who continues to be in the highest tax bracket. Plus, locking in the corpus to an annuity rate applicable in the future is taking a huge risk," said Suresh Sadagopan, founder, Ladder7 Financial Advisories. “I would recommend not more than 20% of one’s money in NPS and the remaining in a mix of Public Provident Fund, exchange-traded funds and mutual funds," he added.
NPS is a low-cost product, and that doesn’t change even if the Irdai draft proposals are implemented, but both products suffer limitations and, therefore, can’t be the main vehicle for building a retirement corpus.