Here is why you should stay away from pension plans

Published: February 22, 2015 at 11:06 am

A long time ago in a galaxy far, far away (that is how the Star Wars movies open), the idea of getting a government job was held in high esteem. Thanks to the boom in the services industry, that is no longer the case among our youth.

However, one remanent from that bygone era continues to haunt us today.  The notion of getting a pension in retirement was something to be proud of those days. If the pension was from the government, it was indexed to inflation, twice a year with dearness allowance hikes. Once a decade or so, the pay commission would hike the pension even further.

Consider this. My mom (a state govt employee) got her first pension in June 2003. Her current pension is nearly four times larger than her first. A CAGR of 12.61%. Her first pension was quite low. Had she been independent, she would have needed additional resources.

Those who retired from companies took their ‘retirement benefits’ and got themselves an annuity from LIC.  Even if this annuity was constant, it was a handsome amount, thanks to the high annuity rates, which was a high double-digit number not too long ago.

Cut to the present, indexed pensions were abolished nearly 11 years ago! The new avatar is the national pension scheme with defined contributions, but no guarantee of returns clubbed with annuity options down the line.

Annuity rates are currently 6-7% for those in the 60-65 age bracket, before taxes.

The highest annual increase in annuity income currently is about 3-5%. Higher, this number, lower the annuity rate!

What about inflation? Inflation in food, fuel etc. fluctuates and have a long-term average of about 6%. What most people forget about is inflation in services (education, healthcare etc.). This continues to be in double-digits with no signs of abating.  So the net overall inflation that one should assume is 8%, minimum and preferably 10%.

So the net overall inflation that one should assume is 8%, minimum and preferably 10%.  This is true before and after retirement. This means that monthly income ought to increase at least 8% (post-tax!)

There is no product in the market which offers this today and I am fairly certain, in the future too.

Which why young earners, far away from retirement should focus on inflation-proof income and not think about pension and buy packed products with the name pension or retirement in them.

Those interested can check out an illustration here: Generating an inflation-protected income with a lump sum

What is the way out?

  1. Start early.
  2. Try to invest as much as you spend or at least as much as you can
  3. Say not to packaged products. Say no to NPS unless your employer offers it. Say no to mutual fund retirement plans.
  4. Build yourself a retirement basket (a term coined by Subra) filled with liquid assets which are productive (equity) and safe (debt). All you need is equity mutual funds + PPF +debt funds.
  5. Upon retirement, follow a retirement bucket strategy. Those close to retirement can play the game or use the simulator.


Do share if you found this useful
Share your thoughts on this topic at the  Reddit freefincal_user_forum

Reach your financial goals like a pro! Join our 1600+ Facebook Group on Portfolio Management! You can now reduce fear, doubt and uncertainty while investing for your financial goals! Sign up for our lectures on goal-based portfolio management and join our exclusive Facebook Community. The 1st lecture is free!
Want to check if the market is overvalued or undervalued? Use our market valuation tool (will work with any index!) or you buy the new Tactical Buy/Sell timing tool!
About the Author Pattabiraman editor freefincalM. Pattabiraman(PhD) is the founder, managing editor and primary author of freefincal. He is an associate professor at the Indian Institute of Technology, Madras. since Aug 2006. Connect with him via Twitter or Linkedin Pattabiraman has co-authored two print-books, You can be rich too with goal-based investing (CNBC TV18) and Gamechanger and seven other free e-books on various topics of money management. He is a patron and co-founder of “Fee-only India” an organisation to promote unbiased, commission-free investment advice. He conducts free money management sessions for corporates and associations on the basis of money management. Previous engagements include World Bank, RBI, BHEL, Asian Paints, Cognizant, Madras Atomic Power Station, Honeywell, Tamil Nadu Investors Association. For speaking engagements write to pattu [at] freefincal [dot] com
About freefincal & its content policy Freefincal is a News Media Organization dedicated to providing original analysis, reports, reviews and insights on developments in mutual funds, stocks, investing, retirement and personal finance. We do so without conflict of interest and bias. Follow us on Google News Freefincal serves more than one million readers a year (2.5 million page views) with articles based only on factual information and detailed analysis by its authors. All statements made will be verified from credible and knowledgeable sources before publication. Freefincal does not publish any kind of paid articles, promotions or PR, satire or opinions without data. All opinions presented will only be inferences backed by verifiable, reproducible evidence/data. Contact information: letters {at} freefincal {dot} com (sponsored posts or paid collaborations will not be entertained)
Connect with us on social media
Our publications

You Can Be Rich Too with Goal-Based Investing

You can be rich too with goal based investingPublished by CNBC TV18, this book is meant to help you ask the right questions, seek the right answers and since it comes with nine online calculators, you can also create custom solutions for your lifestyle! Get it now. It is also available in Kindle format.
Gamechanger: Forget Startups, Join Corporate & Still Live the Rich Life You Want Gamechanger: Forget Start-ups, Join Corporate and Still Live the Rich Life you wantThis book is meant for young earners to get their basics right from day one! It will also help you travel to exotic places at low cost! Get it or gift it to a young earner

Your Ultimate Guide to Travel

Travel-Training-Kit-Cover-new This is a deep dive analysis into vacation planning, finding cheap flights, budget accommodation, what to do when travelling, how travelling slowly is better financially and psychologically with links to the web pages and hand-holding at every step. Get the pdf for Rs 199 (instant download)
Free android apps