Everybody wants to ensure a decent pension amount given the skyrocketing cost of living and uncertainties regarding future. From National Pension Scheme (NPS) to mutual funds, options are varied. How to select the best scheme to safeguard your retirement life?
If you go for a conventional insurance policy or NPS, you have to save up to Rs 7.25 crore in 30 years to get anywhere near your requirement. In other words, you should be able to invest between Rs 25,490 and Rs 76,000 every month to contribute to this corpus.
However, choosing an equity fund SIP will lower your target to just Rs 4.32 crore, or Rs 12,020 per month.
A couple in their 30s, who spend about Rs 25,000 per month, will need Rs 1.9 lakh in pension after 30 years. We have compiled a list of target amounts in available pension schemes and the monthly contributions to realise that. This envisages the amount to ensure pension between 60 years and 90 years.
There are some factors to bear in mind while choosing a pension plan. The first thing to calculate is the amount of money you would need every month after retirement. Your expenses are bound to rise due to inflation. Your current monthly expenses, the number of years in service and your expectations from pension are other deciding factors.
Let us stick to the example of the 30-year-old who spends Rs 25,000 per month. Let us assume that his expenses will go up by 6 per cent due to inflation and another 1 per cent due to lifestyle changes. He has to get Rs 1,90,300 as monthly pension when he turns 60 years old. The amount must increase gradually to Rs 14,48,600 by the time he is 90.
He has to target a corpus of Rs 7.25 crore.
How much should he possess if he were to receive a monthly pension of Rs 1,90,300 at the age of 60?
Returns on investment must be kept in mind while planning pension savings. The money accumulated in the NPS and pension plans are invested in an insurance annuity plan at the time of retirement. You can expect an interest rate of 6.60 percent on average on it. To get Rs 1.9 lakh as pension between 60 years and 90 years at this interest rate, you have to invest Rs 7.25 crore in the plan when you turn 60. That means you have to invest Rs 76,760 every month for 30 years. Needless to say, this is not accessible for the common man.
Insurance plan – high expenses, low returns
The pension plans run by insurance companies come with a high premium because they also offer insurance cover. Traditional endowment plans cut the insurance charges and offer a maximum of 5.8 per cent returns on the rest of the savings. Meanwhile, equity-based ULIPs offer higher returns.
What is NPS?
NPS tier 1 is used for pension.
The scheme invests in equities and bonds. An investor is at liberty to change the ratio of investment.
Returns from bonds fluctuate. This is almost equal to long-term bank interest.
The NPS has features to lower risk and be safe but they lead to lower returns.
There is a limit to equity investment in the NPS. Government employees can invest only 50 per cent of their money in stocks. Others can invest up to 75 per cent.
The share of equities will gradually be reduced. After 50 years of age, the share of equities will be cut by 2.5 per cent every year. Someone who has selected 75 per cent equities will have only 50 percent of equity in his portfolio when he is 60 years. As the share of equities decreases, so do returns.
We can estimate that the NPS investment will yield long-term returns of 13 per cent for the equity share and 8 per cent on bonds on average. A 30-year-old who has opted for 50 per cent equities can expect returns of 9.68 per cent in the 60 years from 30 to 90. If the equity share is 75 per cent, the returns will increase to 10.01 per cent.
The money accumulated in the NPS is supposed to be invested in an annuity fund after 60 years. These funds are not designed to offset current inflation rates.
To receive an inflation-proof pension between 60 and 90 years, you have to invest Rs 7.25 crore in an annuity fund with 6.6 per cent returns. For this, you have to invest Rs 28,000 in NPS with 50 per cent in equities every month. If the equity share is 75 per cent, your monthly contribution will have to be Rs 25,490.
In the case of annuity plans, an investor's premature death would result in the loss of his savings. That means the nominee has no claim over the unused money. In case the investment is made in a scheme which would pass on the money to the nominee, that would not be enough to ensure sufficient pension in old age. In SWPs, the pension amount is received through systematic withdrawal plans. An investor can expect to receive pension as long as he has planned. In case of premature death, the remaining amount will be given to the nominee.
NPS isn't bad after all
The NPS has some strong points as a pension scheme.
Low expenses, high returns – Compared to equity funds and insurance schemes, the NPS scores because its fund management costs are minimal. So the assets balloon in the long term.
As per section 80C of the Income Tax Act, up to Rs 1,50,000 investment in ELSS and insurance plans every year is tax exempt. An additional investment of Rs 50,000 in NPS is also exempted under section 80C CD (1B). In case your employer is investing for you, exemptions apply for that too.
Equity fund and SIP
SIPs in equity funds are excellent means for pension. They are almost similar to investing in stock markets. They tend to offer increased returns when compared to other schemes in the long run. In the short term, returns may not be that attractive though. (The BSE Sensex compound annual growth rate over 40 years was 15.75 per cent. The Sensex was positive for 31 of the 40-year period. It was in the red for nine years. Stocks are the favourite investment method of the rich the world over. If you are a long way from being a pensioner, it is best to go for equity funds that invest in stock markets.
Keep in mind that such plans come with their risks. They are sometimes deemed as not a safe bet for pensions. But the risk can be mitigated with the right amount of planning. What you want to do is to keep gradually decrease the share of equities in your plan as you age.
Plan well, cut risk
How to reduce risk in the pension fund linked to equities?
Calculate the amount of pension you might need every three years after you turn 60 years. You can shift the amount to a balanced fund five years in advance. After two years, shift the money to a liquid fund. After three more years, avail of the money from the liquid fund through systematic withdrawal plans.
In effect, you are cutting your reliance on equity markets five years ahead of your requirement. You are shifting the money you are going to need for three years into a safe liquid fund. That would insulate you against the fluctuations of the stock markets. You can expect returns of 9.5 per cent in the balance fund and 7.25 per cent in the liquid fund.
According to this plan, you will get returns of 12.25 per cent on average during the 60 years from 30 to 90.
That way, you can significantly reduce your corpus target and the monthly investment requirement. You only have to accumulate Rs 4,32,50,000 as pension between the ages of 30 and 60. You only have to invest Rs 12,060 per month. If you keep on adding 5 per cent of the amount every year, you can start with Rs 8,100 per month. If you are looking for tax exemptions, ELSS schemes may be best suited for you.
In NPS, if you invest in a 75 per cent equity-heavy plan, you get only 10.01 per cent returns for 60 years. You have to invest Rs 25,490 per month. You can choose a pension plan that best suits your requirement with the help of a qualified financial planner.
The inevitable fund
We can divide our life into three phases, depending on the flow of income. In the first stage that comprises our childhood and adolescence, we can always fall back on our parents to meet our needs. In the second stage, when we start earning, we are also responsible for the persons depending on us. The third stage is your old age as a pensioner. You have to earmark the money to support you in the final phase when you can. Otherwise you will be pushed to grave financial crises in your old age. You might have to depend on your children or forced to look for work even when you can't.
Longevity is increasing the world over. In 1947, an average Indian could expect to live up to 37 years. In 2016, the life expectancy increased to 68.56 years. In Kerala, life expectancy is 75 years. In Monaco, life expectancy is 90 years and in Japan 84 years. Australians can expect to live up to 83 years.
All this point to the need to ensure a decent amount of pension for maximum years.
In developed countries, people start investing for pension as and when they start working. Even the governments earmark a part of the taxes for social security. In the United States, the pension funds make up 141 per cent of the GDP. In Denmark, pension funds is represented as 2015 per cent of the GDP. In India, the share is a flimsy 1.05 per cent, up significantly from 0.19 per cent in 2011.
A lack of pension fund is a real cause of concern for India. The country will have to deal with an ageing population with no means to support them. The government is doing something to address this problem by introducing NPS and pension schemes.
(The writer is a managing partner of CRG Wealth)