Expert advice

Dec 27, 2012,14.40 IST

Are pension plans worth investing in?

In an interview to CNBC-TV18 Harshvardhan Roongta, Roongta Securities explians if it is worth investing in pension plans offered by various insurance companies.

He advises that only if the investor can manage his fund on his own and is able to stay disciplined only then it is better to plan for retirement on one's own. "One is likely to accumulate a larger corpus than what you will get through pension policies because the policies have very high administrative cost, commissions need to be paid out and there are high salaries and incentives to be paid out to the insurance company employees," he explains.

Also read: Tax sops may boost sagging insurance sector in 2013

Below is the edited transcript of his interview on CNBC-TV18

Q: How are insurance companies now launching pension plans? Do you think pension planning is possibly the most effective way to plan for retirement?

A:  We see a lot of companies now launching pension plans. In 2010, it was the first time insurance regulatory and development authority (IRDA) had issued the first round of guidelines for pension policies. In those guidelines, IRDA had mandated that all the insurance companies' pension plan should have at least minimum guarantee of 4.5 percent returns. But none of the insurance companies were prepared to offer these kind of guaranteed returns, so virtually no products were being launched in 2010-11.

In 2011, IRDA diluted the guidelines which said one of the two thing need to be given that is a positive non-zero returns on all the premiums paid by the investor or the guarantee maturity benefits.

Since the term is very vague in saying that it has to be 'positive non-zero returns', we have now started all insurance companies trying to launch their pension plans which guarantee a minimum of one percent over the next 20 years of the policy. The new guidelines also say that the investor at the time of the retirement cannot go hunting with another insurance company to buy pensions which offer him better returns. This is a huge restriction on the policy holder.

To explain this with an example - if a 30 year old plans for his retirement, which will 25 years hence from now. The pension planning is divided into two parts. The first stage is when you are saving upto retirement. So the 30 year starts saving for the next 25 years for his retirement purposes. The second stage is at retirement which is say 55 years of age; he needs to deploy that fund somewhere to get regular returns which is called pension.

The different options available to investors are one, based on his own risk assessment; he can invest into any product in the first stage which is upto his age of 55 years. He could choose equity, debt, bonds or he could simply put into a recurring deposit and I am sure he will get more than and he surely get 4.5 percent in the least, which the insurance companies are scared to even offer.

Second stage is at retirement and the retirement age is called vesting in terms of insurance parlance. So now at retirement, he has a corpus accumulated and he can park his corpus into fixed deposits, into tax free bonds, into non-convertible debentures (NCDs) or any other product which offers him regular interest, this is called pension.

What the insurance companies in the form of a pension policy offer is the same thing. They break up into two parts just that it is in the form of insurance policy and there are lot of restrictions. First, you cannot pre-pone or post-pone your retirement. In case you have decided at the age of 45 that you have enough corpus and you don't want to work further, but the policy will start paying pension only after the age of 55 because you had entered into a contract accordingly with them. Second, they are very expensive as compared to other investment options.

To sum up if an investor can manage his fund on his own, and he can stay disciplined, it is always better to plan for your retirement on your own because you are likely to accumulate a larger corpus than what you will get through pension policies because the policies have very high administrative cost, commissions need to be paid out, there are high salaries and incentives to be paid out to the insurance company employees. So if you plan it separately, keep it independent then that would be a better way to plan for retirement than to go for these fancy advertisement which promise holidays with meagre pensions that they offer.

If the insuracne company is not able to give you even 4.5 percent guaranteed inflation adjusted returns, then how can one get swayed by fancy advertisements saying that you go on foreign holidays after your retirement.

Q: Since you kept referring to it, what exactly is the service charge or service charges that pension plans levy?

A: At first when you make a premium payment because it is an insurance policy it is called a premium. So, you make an investment which is in the form of a premium. There is an entry load which is levied so it varies from the premium that you pay from company to company.

Secondly there are administrative charges that you have to pay, which is in the form of your fund management charge and fixed monthly administrative charges. If you go in for a non unit-linked policy, the investment pattern is very opaque; you really don't know what is it that your policy is going to generate.

Further on retirement, you are able to withdraw only one third of the corpus that you have accumulated, that is one of the restrictions in an insurance policy. At retirement whatever corpus you have accumulated they will give you only one third of it in your hand. The rest is kept with the insurance company, they give you pension out from that money which is left with them.

Now, as per the new guidelines you cannot even shift and hunt for a better rate. So, you will have to take whatever pension is being offered by insurance companies, which is about 6-7 percent so it is always better to plan it on your own.

Q: National Pension Scheme (NPS) is not an option?

A: NPS is also on the same line though it is much cheaper. Because it is a flagship social security scheme of the government, they try to restrict the expenses which is offering currently at present levels also is better than a pension plan.

But for financial savvy person or a person who can mange his investments he is better off if he manages on his own through an equity or debt portfolio. On retirement, he parks that money at his own discretion as per his risk profile and then he gets regular payments out of it which is called pension.

That is a first option; if not that then NPS and last if you have no other choice then go for a pension plan.

Caller Q: I have still few years for my retirement so is there an age before which I cannot withdraw my pension? Also, is there a scheme in which in case I need to prepone and withdraw the money, which fund do I invest in?

A: No I would say that because it is a pension policy again there are certain restrictions in it. There is an age limit after which the pension can start. Your employer has contracted with an insurance company wherein he is passing on the money to that insurance company to manage it and subsequently offer you superannuation on it.

One you will need to check with your employer whether there are terms which restrict the payment of pension and that your employer would be able to answer that question. However, coming back to the regular pension policy, they are not designed to give you pension earlier than what it has been contracted for.

Secondly withdrawal from pensions is also not the idea behind having a pension plan. You need to keep these things in mind before you decide how you are going to save for your pension in your individual capacity.

As far as your employer is concerned the Employees' Provident Fund (EPF) that you have with your company, you need to check the terms they have entered into with the insurance company and there is where you will get an answer.

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