What is a Pension Plan - Meaning and Types

In ULIPs, the investment risk in the investment portfolio is borne by the policyholder^U.

The Linked Insurance Products do not offer any liquidity during the first five years of the contract. The policyholder will not be able to surrender or withdraw the monies invested in Linked Insurance Products completely or partially till the end of the fifth year.

What is pension ?

It is a fixed sum paid at regular intervals as regular income during your post-retirement years.

What is a pension plan?

It is an investment plan offered by life insurance companies to help create retirement funds. The plan provides a pre-specified and regular pension, preventing financial shortfalls in post-employment years.

How do pension plans work for an individual?

Suppose you are 35 years old and plan to retire at 60 years of age. You estimate is that you will need ₹ 45,000/- per month to maintain your lifestyle post-retirement.

Accordingly, you will need to build a fund within the next 25 years that generates a monthly income of ₹ 45,000/-. This creation of a fund is what a pension plan’s role is: You put in a fixed sum regularly, and your capital grows through investments.

At retirement, you can withdraw a specific percentage of the accumulated funds. The remaining fund generates a fixed, regular income for you during your retirement years.

What are the different types of pension plans available in India?

Annuity insurance plans

An annuity insurance plan provides you with a steady income during your retirement. This income is fixed at the time of purchasing the plan and is guaranteed^> for life. With this income, you can maintain your current lifestyle during retirement. It also helps you achieve your post-retirement goals such as pursuing a hobby, starting a venture, travelling and so on. There are two types of annuities: deferred and immediate.

^> Terms and conditions apply

Immediate annuity plans

With immediate annuity plans, you receive regular income right after you have purchased the plan. These plans are perfect if you are close to retirement and need immediate regular income.

Deferred annuity plans

Deferred annuity plans allow you to grow your savings over time. You can choose a future date when you want to start receiving regular income. These annuity plans can be ideal if you are still a few years away from retirement and want to grow your savings in the meantime.

Pension plans with life cover¹

A pension plan with a life cover¹ offers you the dual benefit of savings for your retirement and financial security for your loved ones in case of an unfortunate event.

National pension schemes (NPS)

The National Pension Scheme is backed by the Government of India and regulated by the Pension Fund Regulatory and Development Authority of India (PFRDA). It can be used by private, public and unorganised sector employees to save for their retirement.

NPS allows you to invest in equity and debt funds. The rate of return can vary based on the funds you choose to invest in.

The scheme matures at the age of 60, after which you can withdraw up to 60% of the balance in a lump sum if the total amount is more than ₹ 5 lakh. 40% of the remaining balance must be used to purchase an annuity from a PFRDA-empanelled life insurance company. If the total amount is up to ₹ 5 lakh, you can withdraw up to 100%.

Employee provident fund (EPF)

The Employees’ Provident Fund is another government-backed pension scheme offered by the Employees Provident Fund Organisation (EPFO). It can be used by employees in the public and the private sectors. In this, both the employee and the employer make contributions towards the employee's EPF account. The total contribution is 24% of the employee's basic salary and dearness allowance, with 12% contributed by the employee and 12% contributed by the employer.

EPF is a retirement scheme meant to be used after you retire, however, you can withdraw your funds prematurely in some cases, such as unemployment or to cover education or marriage expenses, among other things.

What are the benefits of pension plans?

Below are some benefits of pension plans:

• Regular income in retirement: Pension plans ensure a steady flow of income after you retire, helping you maintain financial liquidity
• Life cover: Investment or savings plans offered by insurance companies come with a life cover` . These plans provide the dual benefit of building a corpus for your retirement in parallel with financial protection for your family in case of your untimely absence
• Inflation protection: Pension plans allow your savings to grow over time, helping your money keep pace with inflation
• Peace of mind: Knowing that you have a reliable source of income in place brings peace of mind and takes away the stress 
• Tax* benefits: Pension plans are eligible for deductions under the Income Tax Act, 1961. The amount saved from paying tax can be re-invested or used for some other purposes

What are the key factors to consider when choosing the right type of pension plan?

Below are some key factors to consider while choosing the right retirement plan for you:

• Life-stage: When you are young with fewer responsibilities, you can explore higher-risk pension plans that may offer better returns. As you get closer to retirement, you might want to shift towards low-risk plans that provide stability and guaranteed^> income for retirement.
^> Terms and conditions apply
• Retirement goals: You may want to start a new business, pursue your hobbies or travel after you retire. You must consider the amount you will need during your retirement and how long you have to save. This will help you determine the type of pension plan that suits your needs.
• Risk: Your risk appetite is an important factor to consider while choosing a pension plan. If you have a low risk appetite, you can choose low-risk plans that offer a fixed rate of return and are not market-linked. If you have a high risk appetite, you may consider a plan that provides market-linked returns and the potential for high returns.
• Returns from the plan: The returns from your pension plan will depend on the type of pension plan you choose. You can select from participating, non-participating, market-linked, or fixed income pension plans. While participating and market-linked plans offer higher returns, they come with higher risks. On the other hand, non-participating and fixed income plans provide more stability with lower risk.
• Returns outpacing inflation: It is essential to choose a pension plan that offers returns that outpace inflation. This helps protect your savings from the effects of rising prices, ensuring that your funds retain their value and last longer throughout your retirement years.
• Bonus and other benefits: Pension plans may offer bonuses or additions that enhance your retirement corpus. You must explore such features when evaluating different types of pension plans.
• Tax implications: Taxes can affect your overall returns, so it is important to know how your pension plan is taxed. This can enable you to make better decisions to optimise your finances.
• Fees: Make sure to review the fees and charges associated with each retirement plan. These charges may include premium allocation, policy administration, mortality charges and more. These costs can affect your long-term returns, so it is important to understand their impact.

What is commuted pension and uncommuted pension?

With a commuted pension, you receive a lump sum amount at the time of retirement. This gives you immediate access to a large portion of your pension money, which can help cover major expenses.

On the other hand, an uncommuted pension is paid to you as a regular income in monthly, quarterly or annual payments. This option provides you with a steady and reliable source of income throughout your retirement.

How to build your retirement corpus with a pension plan?

Building your retirement corpus with a pension plan starts with evaluating your financial needs and retirement goals. Once you have clarity, you can choose from several options listed below:

Unit linked insurance plans (ULIP)

ULIPs combine insurance coverage and investment, helping you cover two main retirement needs - wealth to cover your financial needs and life coverage to protect your loved ones. ULIP plans will invest a part of your premium amount in the market linked funds. Consistently investing in the ULIPs for a long time will help your fund to grow over time and the accumulated corpus would help plan for your retirement in your own terms. Additionally with this investment you also enjoy tax* benefits on premiums paid and the maturity amount as per the Income Tax* Act, 1961.

National pension scheme (NPS)

If you are looking for a retirement product backed by the government with market-linked growth, NPS can be a good option. It allows you to benefit from compounded growth along with offering tax savings under 80CCD (1B)*.

Public provident fund (PPF)

PPF is another government-backed option that offers a fixed interest rate and tax-free returns. It is ideal if you prefer a low-risk, long-term savings plan. You can also enjoy deductions under Section 80C*.

Employee's provident fund (EPF)

If you are a salaried employee, EPF can be a structured way to save for retirement. Both you and your employer contribute to the fund, and the accumulated corpus earns interest. EPF is also eligible for tax benefits under Section 80C*.  

Conclusion

Now, you know what does pension means and how it functions. It ensures financial security in your retirement age, helping you live a happy and fulfilling retired life.

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