Manikaran SingalCertified Financial PlannerRetirement and pension are synonymous to each other. Whenever one thinks about saving towards retirement, he starts searching for a pension plan. Investors have started feeling that buying pension plan will only take them to a secure retirement. But if one has a clear understanding on structure of products and also how retirement planning should be planned for, then I am sure that one would definitely go for much better manageable and more flexible products called mutual funds. This article is about how one should use mutual funds towards better and tax efficient retirement planning.
Before going ahead on products, let me share a bit about retirement planning so the selection of products become easy. Retirement planning has three steps – accumulation, preservation and distribution. In accumulation stage you invest in different investment products based on your risk profile and time horizon towards retirement. Preservation and distribution stages go parallel to each other and these stages come after getting retired. In these stages the main goal of investor is to preserve the amount accumulated and also keep on getting some income out of it to take care of retirement expenses. Pension plans by Insurance companies and new pension scheme also works on the same concept.
During initial part of the tenure money gets accumulated and in the latter part money gets distributed. But there are some problems with pension plans in general due to which I never recommend it to be used for retirement savings. Mutual funds are comparatively very tax efficient and flexible investment instruments which can be used for effective retirement planning. There are different varieties of mutual funds which can be used for every stage of retirement planning. Let’s get into some details.
Using Mutual Funds in Accumulation stage of Retirement Planning:An investment at this stage is just like normal investments that you make after understanding your risk profile, time horizon and mutual funds structure. With a variety of mutual funds available you just have to decide on the asset allocation that you want to go with and you can make a combination of equity, debt, gold and real estate. As retirement savings are generally of very long term nature so you can select among diversified equity funds which may include a combination of Large and Mid-cap funds, also in case of debt allocation you may go with long term debt funds. For gold allocation there are different gold ETFs or gold savings fund available and if you have a flair for real estate now you can invest in different real estate portfolios which these days comes under alternate investment category of funds.
Using Mutual funds in Preservation and distribution stage of Retirement Planning:At this stage one need to be on conservative side and follows a defensive approach. So one can take call on safe products like Short term debt funds, fixed maturity plans, monthly income plan. As along with preservation one also needs to generate regular income, so one may opt for Systematic withdrawal or dividend payout options. In Systematic withdrawal option investors give instruction to mutual funds houses to start paying a fixed amount after selling out the units available. This structure takes care of regular income need of investor.
Why Mutual funds are better than pension plans.You must be thinking that when you can get all these benefits in a single product like pension plans, then why you should take so much stress on selecting Mutual funds and making other arrangements. To clear your doubt let me point out few advantages of Mutual funds over pension plans.
1. Mutual funds are more flexible investment products: Unlike pension plans it does not have any restrictions on the regular premium payment, or making complete or partial withdrawals in between. You can discontinue your investments or make partial withdrawals, with no penalties. 2. Mutual funds are tax efficient instruments: Long term capital gains booked under equity mutual funds are completely tax free and in case of debt mutual funds it is 10% before indexation or 20% after indexation. Many times it has been seen that after adjusting indexation the capital gain tax in case of debt funds also comes out to be as NIL. Thus Systematic withdrawal proves to be a very tax efficient option as compared to pension which is added in your income and thus is 100% taxable.
3. Mutual funds are more transparent and investor friendly: In Mutual funds you can select funds as per your choice. The information regarding the Fund manager, investment objective, strategies, past returns, risks associated etc. are publically available but pension products are not that transparent.
I think pension plans do offer one advantage which is discipline. You invest in pension plan just with a view point of getting pension and keep on saving till retirement. But if you can create that discipline in yourself regarding all your other investments, you can design your tax efficient, flexible and better retirement plan through Mutual funds.
The author is Certified Financial Planner and a member of The Financial Planners’ Guild, India (FPGI). FPGI is an association of Practicing Certified Financial Planners to create awareness about Financial Planning among the public, promote professional excellence and ensure high quality practice standards.
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