Pension Plans: Look Before You Leap

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LIC agents  are busy advertising  the Varishtha Pension Bima Yojana. An annuity product which would hand out a ‘pension’ against a lump sum payment at an annual return of a little more than 9%.

Here is why you should not consider any pension product at face value.

  • The pension received is typically constant for life. If it increases by 3 or 4%, the pension amount would be significantly lower.
  • The pension is taxable as per slab.  There are more tax efficient options available: Debt mutual funds and tax-free bonds. With a debt mutual fund, only the capital gain is taxed upon redemption. The taxation is with indexation benefit if the units are above 3 years old. The tax outgo would depend on inflation. There could be no capital gain and therefore no tax, if the inflation is high enough. Even for someone in 10% slab, a debt mutual fund is a better option that a pension plan.
  • Your money is locked up in a pension plan. There are several options available upon death of the policy holder (pension to the spouse, return of purchase price etc.) but none of these options can match one in which the retiree has, not only access to the  entire corpus, but also can allow it to grow in different buckets of varying risk.  See this for details:  Generating an inflation-protected income with a lump sum
  • As for  Varishtha Pension Bima Yojana, the maximum pension is Rs. 5000 per month.  So it not meant for people who use computers!
pension plan
Photo Credit: StockPhoto

Most retirees do not have a corpus big enough to generate an income that grows each year by about 7-8%.  Should such people settle for such pension plans?

NO. They can invest their money in such a way that income grows at least by 2/3% each year in a tax efficient manner.

In general, pension plans should not be purchased immediately upon retirement when the retiree is in fairly good health and can manage his/her own finances or let a professional do it.

If  a 60 year old retiree invests his/her corpus intelligently, he/she can buy an annuity 15, 20 years later, when  too old to manage the corpus. The annuity in such a case would be considerably higher.

Stay away from all Bimas and Yojana.  Instead, come up with your own personalised yojana!

With inputs from Rajendra Dixit and Narendra Kondajji.

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About the Author M Pattabiraman author of freefincal.comM. Pattabiraman(PhD) is the author and owner of freefincal.com.  He is an associate professor at the Indian Institute of Technology, Madras since Aug 2006. Pattu” as he is popularly known, 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. Pattu publishes unbiased, promotion-free research, analysis and holistic money management advice. Freefincal serves more than one million readers a year (2.5 million page views) with numbers based analysis on topical issues and has more than a 100 free calculators on different aspects of insurance and investment analysis. He conducts free money management sessions for corporates  and associations(see details below). Previous engagements include World Bank, RBI, BHEL, Asian Paints, TamilNadu Investors Association etc. Contact information: freefincal {at} Gmail {dot} com (sponsored posts or paid collaborations will not be entertained)
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36 Comments

  1. Great advise in simple and easy to understand terms. My dad was wary of the 'Generating an inflation-protected income with a lump sum' strategy but now after reading this verdict, there is more faith and will continue on the path of buckets for getting maximum although his retirement is still far away.
    As for Varishtha Pension Bima Yojana, the maximum pension is Rs. 5000 per month. So it not meant for people who use computers! What do you mean by this Pattu ?

  2. Great advise in simple and easy to understand terms. My dad was wary of the 'Generating an inflation-protected income with a lump sum' strategy but now after reading this verdict, there is more faith and will continue on the path of buckets for getting maximum although his retirement is still far away.
    As for Varishtha Pension Bima Yojana, the maximum pension is Rs. 5000 per month. So it not meant for people who use computers! What do you mean by this Pattu ?

    1. It is not a counter view. Re-read his article again. Besides, like I mentioned this plan is not for those who can access the internet. Not much can be done with 5K monthly pension.

    1. It is not a counter view. Re-read his article again. Besides, like I mentioned this plan is not for those who can access the internet. Not much can be done with 5K monthly pension.

  3. Thanks for the article. I completely agree your views. I personally think annuity is one of the worst forms of income generation for retirement. It goes completely against the basic philosophy of personal finance – diversification.

    First of all you do NOT want to put all your eggs into one single basket. Secondly annuity returns are so low in india when compared to the inflation rates, depending on it for your comfortable retirement life is highly dangerous, especially if you retire early since the money is completely locked and you cant do anything after you invest..

  4. Thanks for the article. I completely agree your views. I personally think annuity is one of the worst forms of income generation for retirement. It goes completely against the basic philosophy of personal finance – diversification.

    First of all you do NOT want to put all your eggs into one single basket. Secondly annuity returns are so low in india when compared to the inflation rates, depending on it for your comfortable retirement life is highly dangerous, especially if you retire early since the money is completely locked and you cant do anything after you invest..

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