A factor you must consider when saving for retirement is getting a return kicker by looking at some market-linked investments, too. In fact, some retirement products are designed in a way to accommodate debt as well as market-linked elements. A look at some options.
Mutual fund products
Mutual funds (MFs) offer two kinds of retirement products - ones that offer tax deduction and other that don't. Let's call schemes that offer tax deduction type I and those that don't type II.
Besides the difference in tax treatment, type I and type II schemes' investment pattern differs significantly. While type I schemes primarily invest in debt, irrespective of the age of investor, type II schemes mainly invest in equities until the time the investor nears the age of retirement. Typically, after the investor crosses 60 years of age, the fund begins to invest primarily in debt to secure your capital.
Type I schemes in the market: Templeton India Pension Plan and UTI Retirement Benefit Fund are the two options avainable. Both the schemes invest 40% of the corpus into equity and the balance into debt. These funds are relatively safe, but they do not guarantee your capital. On the other hand, several MF companies offer type II schemes. Since type II schemes mainly invest in equities, long-term returns may be higher as compared with type I schemes.
Assuming the same rate of return, type 1 schemes are better because of the tax deduction factor. Sample this: you invest Rs 25,000 every year for 20 years and the scheme charges an expense ratio of 2%. At 10% per annum your corpus would be Rs 12 lakh. In a type 1 scheme, if you factor in the tax deduction, you will save Rs 7,725 every year assuming you are in the highest tax bracket of 30.9%. Over 20 years, this would add up to Rs 2 lakh. But type 1 schemes tend to lose their edge if the returns from equity are very high.
The problem: Both type I and type II schemes have an easy exit option. By paying an exit load, you can redeem your investments and this can dent your retirement savings.
The cost structure of pension products from insurance companies is better, but they invest heavily in debt products.
Let's sample a policy from the Life Insurance Corp of India (LIC). LIC's Pension Plus is a regular premium policy that offers two options - one invests up to 100% in debt, while the other limits debt exposure to 65-85%. It has a premium allocation charge of 6.8% in the first year, 4.5% from the second to fifth years and 2.5% thereafter. The fund management charge is 0.7% for the debt fund and 0.8% for the mixed fund.
Assuming a return of 10% over 20 years on an investment of Rs 25,000 every year, the policy will return Rs 13 lakh. Throw in the additional Rs 2 lakh - the premiums of pension policies qualify for a tax deduction under section 80C-and the total corpus at the end of 20 years stands at Rs 15 lakh.
The problem: According to guidelines issue by insurance regulator the Insurance Regulatory and Development Authority, insurance companies need to provide a minimum guaranteed return of 3-6% on the total premiums paid. To fulfil the requirement, insurance companies invest predominantly in debt and hence the returns are conservative.
National Pension System
Like MF and insurance products, the National Pension System (NPS) also invests in a mix of equity and debt. The scheme allows for three investment options: equity (E) in which a maximum of 50% can be invested, fixed income instruments other than government securities (c) and government securities (G).
Among all retirement products, NPS charges the least. Your investment of Rs 25,000 per year for 20 years at an annual return of 10% per annum would give you Rs 16 lakh. Also, since NPS provides tax deduction, indirect savings can yield another Rs 2 lakh.
Moreover, the structure of NPS is such that it allows for no leakages. The scheme has a strict lock-in till 60 years of age. If you wish to withdraw before you turn 60, the system discourages you by annuitising at least 80% of your corpus: it buys an annuity product that gives periodic income.
If you are a conservative or balanced investor, NPS is best suited for you. Type 1 MF schemes and debt-oriented pension plans are best avoided. For risk takers or equity investors, we recommend equity diversified mutual funds for wealth accumulation.