Saving up for an individual pension plan is an essential part of wealth management. Read the below case to get an idea.
Meera is a 25-year-old marketing professional who wants to secure her future after her retirement. So, she researched retirement options and consulted with a financial advisor. She enrolled in pension schemes with additional tax benefits. With a diversified portfolio comprising mutual funds, stocks, bonds, and a mix of other asset classes based on her age and risk profile, she set a specific corpus retirement goal and committed to regular contributions.
Thus, planning your retirement is an important segway to long-term stability. Let’s find out how pension plans work, its types and how to choose the right plan for you.
What is a pension plan?
An individual pension plan provides you with a regular income post-retirement. It’s an essential part of your retirement planning process. In the pension plan, contributions are made during your working years by your employer, government or other organisation. So that after your retirement, you can receive a steady income when you are no longer working.
What is the best age to retire?
The “best” age to retire depends on your circumstances, such as financial situation, health, personal goals, and job satisfaction.
Some people aim for early retirement, often in their 50s or even 40s. This requires a substantial amount of savings and investments, as it involves funding a longer retirement period. It is popular among those who follow movements like FIRE (Financial Independence, Retire Early), who save aggressively to retire decades earlier than traditional ages.
How do pension plans work?
During your working years, you are a potential pensioner. That is your investment period. You regularly invest money into your pension fund. This period lasts until the contributions stop, usually upon reaching retirement age. The money invested grows over time and accumulates to become a significant corpus by the time you retire.
After the investment period, begins the vesting period. This is the phase that begins when the investment matures, i.e., you retire and start receiving a regular income from the pension plan.
What are the different types of pension plans in India?
In India, there are many types of pension plans for your retirement goals. Here are some of the pension schemes that are offered in India:
- National Pension Scheme (NPS)
NPS is a government scheme that offers both pre and post-retirement benefits. This scheme is for all; public, private and unorganised sector employees. It also has tax benefits such as exemption up to ₹1,50,000 under 80C and an additional ₹50,000 under 80CCD(1B) of the Income Tax Act. The best feature of this scheme is that it has an additional EEE tax benefit which means investment, return and amount due at maturity all are exempt from income tax.
- Public Provident Fund (PPF)
PPF is a long-term investment with a lock-in period of 15 years. It gives you the option to take your retirement funds in lumpsum or instalments in a financial year. PPF also has an EEE tax benefit.
- Atal Pension Yojana
This government scheme is primarily for the unorganised sector. It guarantees a pension of ₹1,000 to ₹5,000 (depending on your contribution amount and time period of your contribution) upon attaining 60 years of age. The contribution amount starts from ₹125 and can be started from the age of 18.
- Employees Provident Fund (EPF)
EPF is one of the pension schemes that create a retirement corpus through monthly contributions from both employees and employers. The amount of benefit received depends on the employee’s contributions, the length of service and the rate of interest earned on the investments made by the Employee Provident Fund Organisation (EPFO).
- Retirement-Focused Mutual Fund Schemes (Solution Oriented Mutual Fund Schemes)
Such schemes are market-linked investments providing both liquidity and tax benefits.
Retirement-focused mutual fund schemes give you a steady source of income during your retirement years. These types of mutual funds typically invest in a mix of stocks, bonds and dividend-paying securities to help generate regular income. If you want to know how much your SIP’s potential returns could be, check out this SIP calculator.
How do I choose the right pension plan for me?
Choosing the right pension plan for you is dependent on three factors- affordability, risk appetite and future goals.
Knowing your financial position while assessing your pension plan is essential. You must determine how much money you can afford to set aside for a pension plan. Then, you must know how much risk you are willing to take. Your individual pension plans can vary in terms of associated risks depending on the investment vehicles used (e.g., equity vs fixed-income securities). Lastly, you should calculate potential costs for daily living, healthcare, and any other foreseeable expenses. This will help you decide at what age you plan to retire, which will in turn determine the duration over which you need to accumulate funds.
What happens to my pension plans when I change jobs?
In India, when you change jobs, your pension plans can be transferred to a new employer or consolidated into an individual retirement account. If you are a member of a defined contribution plan, the money in your account is usually rolled over or transferred to your new employer. With defined benefit plans, a portion of the money in your account is usually paid out to your new employer and the rest is paid to you.
What is UAN?
UAN, which stands for Unique Identification Number, is a 12-digit number assigned to individuals by the EPFO in India. It is used as a primary key to identify an individual’s provident fund account. UAN is used to track and manage the employee’s provident fund contributions, withdrawals and other transactions. It can be verified online by the employee or the employer through the EPFO website.
How much money will I need to retire?
The financial aspect of an individual pension plan is very important. The key things to consider are your retirement goals, inflation, healthcare costs, life expectancy and if you have other income sources. So, to build your retirement corpus, you must calculate according to your specific goals.
To know how much money you will need to retire easily, click here.
Want to know more about Index Funds? Click here.
Should I invest in index funds for my retirement?
The best way to passively contribute to your retirement funds is index funds. You should consider investing in index funds for the following reasons:
- Low cost
Index funds generally have lower fees, since they aren’t actively managed. So lower transaction costs. This allows more of the dividends to flow through to shareholders. This can be beneficial for people who rely on income generation through dividends.
For those preferring rebalancing to meet living expenses, index funds are pretty straightforward to manage. Being pure plays on specific asset classes makes it easy to identify and trim appreciated assets to generate cash flow while maintaining the specific asset distribution.
- Easy to manage
Index funds require less oversight compared to actively managed funds. The performance of funds is less dependent on the fund manager’s skills and more on the market performance. They often have lower and more stable expense ratios, which have been trending down over the past decade. All in all, they provide a diversified exposure across sectors, requiring less micromanagement.
- Rupee cost averaging
By investing a fixed amount at regular intervals, index funds help you to buy more units when prices are low and fewer units when prices are high. This potentially decreases market volatility and can lead to higher long-term returns compared to lump-sum investing. So, index fund investors can capitalise on the market’s ups and downs over time.
Index funds have many benefits for you. So, while planning your retirement, select an investment strategy that matches your financial needs. Index funds are a good choice for your retirement corpus due to their low costs, tax efficiency, simplicity of maintenance, effective cash flow management features and risk control capabilities. These factors collectively contribute to a potentially more stable and straightforward investment strategy that aligns well with the financial needs and lifestyle goals.
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