Here is why you should stay away from pension plans

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. fluctuate and have a long-term average of about 6%. What most people forget about is inflation in services (education, health care 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.

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12 thoughts on “Here is why you should stay away from pension plans

  1. Tulasidhar

    Thanks for your blog, I get financial enlightenment. However I am confused by your statement "Say no to NPS unless your employer offers it. Say no to mutual fund retirement plans." Can you clarify. My Employer does offer "optional" NPS contributional facility under 80 CCD i.e I can either choose my employer to contribute to NPS or make it part of my salary. In this case, do you think NPS is preferable?

    Reply
  2. Tulasidhar

    Thanks for your blog, I get financial enlightenment. However I am confused by your statement "Say no to NPS unless your employer offers it. Say no to mutual fund retirement plans." Can you clarify. My Employer does offer "optional" NPS contributional facility under 80 CCD i.e I can either choose my employer to contribute to NPS or make it part of my salary. In this case, do you think NPS is preferable?

    Reply
  3. Lalit Tyagi

    Nice article as usual from your professor. Thanks.
    Thankfully, I belong to pre-NPS era as joined central govt. service in 2000. What a relief :). But, yes, even then can't rely solely on it due to ever increasing inflation. So still wants to build a retirement kitty.

    Reply
  4. sundararajan

    I heard about SBI saral pension plan recently. It is hard to believe on the pension amount and some other aspects and I am still not clear about some points of that. The plan that I discussed is as follows.
    Invest Rs 10 lakhs per year for 10 years. From 11th year, one gets Rs 14 lakhs pension per year which is way above the current annuity rate of 7% from SBI life. Also I was told that I could opt for 33% at the time of maturity. Both this 33% and pension are not taxable (told), but not sure if this will be still true in another 10 years. Corpus will be paid to the nominee at the end. It looks like reasonable (risk and reward wise). I know anything comes with risk. I did run couple of options. Would like to know if there is any traps on this Thanks

    Reply

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