This article has been published in “DNAINDIA” on 11th October, 2016
Gone are the days of predominantly government jobs which assured a regular monthly pension after retirement. The government has also moved away from ‘defined benefit’ pensions for those who have joined post-2004.
And, of course, those of you in the private sector have no such luxury anyway.
People working in the private sector need to plan their own pension. The moment income stops, the effect of rising cost of living becomes devastating. You may retire today at 60 with a house of your own and think ?15,000 per month would suffice for your needs. By the time you are 80, you would need about ? 1 lakh per month in order to maintain your standard of living.
In this context, it is unfortunate that there are no good annuity products in India. Rather than accept a lump sum, most annuities force you to contribute for several years as that’s where brokers and insurance companies make more money. The few pure annuities that are out there are very poor in terms of their returns – a meagre 6.7%. Even the humble fixed deposit in a public sector bank would give you around 7.5% if you are a senior citizen.
The first lesson from this analysis is that you need to avoid any annuity product readily available in the market.
The second takeaway is that while the fixed deposit is far better than an annuity product, it still doesn’t protect you from rising cost of living. To protect against this situation, you have no option but to keep a small portion in equities, which can deliver a boost to your returns.
So, what’s a good alternative?
A type of mutual fund called the ‘monthly income plan’ (MIP) is a good option to create your own pension.
It invests 70%-80% of its money in very safe debt – like government securities. This portion often yields 6%-8% in the current environment. To provide a returns boost over the long term, it invests the balance 20%-30% in the equity market. MIPs are offered by practically all leading mutual fund houses such as ICICI, HDFC, Birla, Kotak, SBI, etc.
The MIP is a great retirement product that can provide regular income for 20-30 years of retired life. By choosing an appropriate option, you can have withdrawals set monthly, quarterly, yearly, or simply when you want.
The word ‘monthly income’ in the product doesn’t mean you necessarily need to draw a monthly pension from it.
The tax treatment of MIPs is superior to fixed deposits. If you hold an MIP for over three years, capital gains are taxed at 20%, with the benefit of indexation.
Here is an illustration of 10-year returns earned if you had invested ?10 lakh in 2006 – in a good MIP versus a fixed deposit. Clearly, the MIP has the potential for better returns and better protection from inflation in your retired life.