Saving options for retirement

One goal for which all working professionals and those in the non-entrepreneurial segment must plan and prepare for, is retirement. Awareness levels are improving, with investments increasing in such avenues as mutual funds. But a systematic approach to saving for your silver years is critical.

The more popular options are mutual funds and unit-linked pension plans. There are other choices such as dedicated retirement mutual funds, the national pension system (NPS), both of which are market-linked, and pure debt options such as PPF, EPF and VPF.

Evaluate these options carefully, create a suitable asset allocation policy according to your risk appetite and invest and step-up amounts regularly to reach your targeted retirement kitty.

We discuss each of these options across important investment considerations such as costs, liquidity, portfolio composition and taxability.

MFs, retirement schemes

The plain-vanilla diversified equity fund is an ideal choice for saving towards long-term goals such as retirement.

There are large-, multi-, mid- and small-cap schemes, apart from tax-saving and value-oriented ones. With market regulator SEBI’s strict guidelines on investing in stocks of various market capitalisations, fund houses are forced to adhere to mandates without much scope for deviation.

In the last 10 years, despite numerous fluctuations in the market, these categories have delivered 16-21 per cent returns (annualised). The benchmark Sensex TRI grew at around 17.8 per cent.

Taking a slightly long-term view, the Sensex TRI grew by about 11 per cent annually in the last 25 years, while the best large-cap schemes delivered 19 per cent over this period.

But in recent years, with SEBI’s norms on reclassification of schemes and a rather narrowly-led rally in the markets, large-cap schemes are increasingly finding it difficult to even match benchmark returns.

Therefore, you can invest in index schemes and exchange-traded funds (ETFs) instead of actively-managed large-cap schemes. Go for active small- and mid-cap funds, as there is still sufficient scope for out-performance in these segments.

Invest systematically over the years, rebalance your portfolio periodically, exit prolonged under-performers and replace them with quality funds. If you reach your target ahead of time, exit the units and move to safe debt schemes such as bank deposits or very high-quality debt funds that invest only in gilt and AAA-rated instruments.

Then, there are dedicated retirement mutual funds. Apart from Franklin India Pension and UTI Retirement Benefit Pension — both notified funds enjoying deduction under Section 80C — Tata, Reliance and, more recently, HDFC have rolled out retirement mutual funds. ICICI Pru and Aditya Birla SL too have launched retirement schemes.

Tata’s Retirement funds (with three options) have a track record of more than five years and have delivered returns in excess of standard benchmarks and peers.

Retirement funds have a limited record. Tata Retirement has been the best of the lot in the last five years. The progressive and moderate plans of the scheme, both of which have an equity bias, have delivered more than 18 per cent over the past five years.

UTI Retirement and Franklin Pension are debt-oriented balanced funds with a 40:60 debt-equity allocation. These two have delivered 10-11 per cent in the past five years, which is reasonable compared to returns of balanced hybrid funds.

If you already have a portfolio dedicated to retirement, with a blend of diversified funds across market capitalisations, you can stick to it for your goal. You can consider retirement funds if you have exhausted the above option, have a surplus to be deployed and wish to diversify to a new fund management company to benefit from a different style.

Portfolio disclosure: These are the most transparent schemes that disclose their holdings every month. The expense ratio is known upfront and there are no hidden charges that you need to be wary of.

Costs: Mutual funds have fairly transparent cost disclosure norms. The NAV of a scheme is given after taking the expense ratio into account.

Index funds charge 1-1.5 per cent, while ETFs have an expense ratio of around 0.5 per cent. Actively-managed funds charge 1.6 to 2.75 per cent. Retirement mutual funds have an expense ratio of 2.3-2.8 per cent. In all cases, direct plans would cost you about 30-50 basis points lower.

Taxability : Only the Franklin and UTI retirement plans enjoy deduction under Section 80C of the Income Tax Act. These are debt-oriented hybrid funds and, hence, gains are taxable. If held for three years or more, you need to pay long-term capital gains tax at the rate of 20 per cent with indexation benefits. Gains from debt or debt-oriented funds held for less than three years are taxed at your slab. Capital gains (in excess of ₹1 lakh) from equity funds are taxed at 10 per cent if units are held for more than a year. Profits from units held for less than a year are taxed at 15 per cent.

You can opt for a systematic withdrawal plan, post-retirement, and take out amounts you require; of course, you need to keep the tax implications in mind.

National pension system (NPS)

As an important retirement investment vehicle, the national pension system (NPS) offers considerable diversity — equity, government debt and corporate bonds.

There are eight fund managers for the NPS — ICICI Pru, HDFC, LIC, Kotak, SBI, Reliance, UTI and Birla Sun Life. Except Birla Sun Life, all other fund managers have a track record of over five years.

All you need to invest to keep your account active is ₹1,000 a year. There is no restriction on the maximum amount you can invest.

You can choose allocation to different invest avenues. The maximum proportion you can allocate to equity in the active choice mode is 75 per cent up to the age of 50.

The proportion would have to be reduced progressively after 50 and brought to 50 per cent by the time you turn 60.

There is also an auto option. Within that option, there are three choices. Depending on your risk appetite, you can have equity allocation of 75 per cent, 50 per cent and 25 per cent. There is an automatic reduction in equity allocation in these three choices with each passing year.

Given that the investment universe for the equity portion of the NPS is restricted to index funds and Sensex, Nifty 50 and Nifty 100 stocks, fund managers have stuck to the mandate.

The portfolios are not that actively managed and these fund managers tend to buy most of the stocks in the Nifty 50 basket, and a few from the Nifty 100 index.

These fund managers managed to deliver 11-13 per cent annually over the past five years. SBI, UTI, HDFC, Kotak and ICICI managed returns in excess of 12 per cent, matching benchmarks such as Sensex and Nifty.

NPS gilt fund managers have managed to juggle the average maturity profile of their holdings and tweak the modified duration, so as to gain from the changing interest rate scenarios.

Modified duration measures the sensitivity or change in the price of a debt instrument to a change in interest rates.

Most managers have invested in listed Government of India securities maturing from 2028 to 2051. In addition, they have also taken exposure to various State Government development loans.

In the last five years, the gilt option of these fund managers has delivered 10-11 per cent, with LIC leading the way, and has outperformed the actively-managed gilt mutual fund category.

The story is similar to the corporate bonds category as well with returns of 9-10 per cent delivered over the past five years. For urgent needs such as hospitalisation of certain illnesses, education needs of children, purchase of house, you are allowed partial withdrawals.

Portfolio disclosure: NPS fund managers disclose their portfolios periodically, usually monthly or, in some cases, semi-annually. Investments are generally made by taking low-to-moderate risks and are suitable for a wide range of investors.

You can enrol in the NPS directly online or through a distributor.

Costs: There are account opening charges of ₹40 and an annual maintenance fee of ₹95 for NSDL. Another ₹3.75 is charged to the investor for every transaction. Karvy charges lower amounts in all these cases.

In addition, there are point-of-presence (distributor) charges of ₹200 during initial registration; 0.25 per cent of the value of subsequent investments; ₹50 per annum for subscriber persistency. For contribution through eNPS, the PoP charges are only 0.1 per cent. The investment management fee is only 0.01 per cent per annum. There are a couple of other very minor charges as well.

But on the whole, after the initial registration and subscription, charges are quite low.

Taxability: NPS enjoys tax deduction under Section 80 CCD. Your investment of up to ₹2 lakh in NPS is allowed as deduction from your income. This is, of course, including the ₹1.5 lakh deduction under Section 80C. After you turn 60, the accumulation phase would be over. Of the total corpus, 60 per cent can be withdrawn, which is tax-free. The remaining 40 per cent has to be used to buy annuity by taking a policy from an insurance company.

Unit linked plans

Another market-linked product that is dedicated to retirement is the unit-linked pension plan offered by insurance companies.

Insurers such as Bajaj Allianz, HDFC Life ICICI Pru and SBI Life offer pension plans.

Typically, there is an accumulation phase, during which time you pay your premiums regularly (yearly, quarterly or monthly).

These amounts are invested in the funds of these insurance companies — options include investing in equity, debt or hybrid schemes. The mandates and nomenclature of these funds aren’t rigid like in the case of mutual funds.

Depending on the type of funds chosen, returns over the last three years have ranged from 6.5 per cent to 14.1 per cent. Over a five-year timeframe, returns have ranged from 7.3 per cent to 12.6 per cent. These are returns before deduction of charges. Actual returns would, thus, be lower.

Insurance companies allow you to switch between funds in case you feel returns do not meet your expectations. Once the accumulation phase is completed, you come to the withdrawal phase. You will need to buy annuity with at least two-thirds of the accumulated corpus and can withdraw the remaining amount.

If you have a surplus after investing in mutual funds and the NPS, you can consider ULPPs as an option. It should form only a small portion of your retirement portfolio.

Portfolio disclosure: Unit-linked pension plans disclose the portfolios of their funds once a month. Disclosures have improved in recent years, in the light of regulatory pressure and greater focus on transparency.

Costs: Given that there is an investment component and an insurance component in any unit-linked plan, there are mortality charges along with a host of other expenses (policy administration, fund management, premium allocation etc.) charged by insurance companies. The fund management charge is usually 1-1.35 per cent. There is an investment guarantee charge of 0.4-0.5 per cent. Policy administration expense is 0.3-0.4 per cent.

Taxability : Proceeds from unit-linked plans enjoy tax-free status under Section 80DD if the sum assured is at least 10 times the annual premium. The premiums paid can be claimed for deduction under Section 80C. At the time of withdrawal, one-third of the amount accumulated is tax-free. The remaining two-third has to be invested in annuity.

Public provident fund

As one of the safest and most attractive long-term debt options, the public provident fund (PPF) has become more lucrative with the government increasing the interest rate for the October-December quarter to 8 per cent. The same rate would prevail for the January-March 2019 quarter as well. The rates are reviewed and set every quarter.

In addition, the tax benefits of the product make it a must-have for most investors’ portfolios.

PPF is a debt product spread over a period of 15 years, and is ideal for saving towards long-term goals. You can invest up to ₹1.5 lakh every year over this period. Interest rates are revised every quarter for the instrument. You need to invest a minimum of ₹500 every year to keep your account active.

The 15 years are counted from the end of the financial year in which the first instalment was paid. So if you open a PPF account on October 1, 2018, the 15-year tenure starts from April 1, 2019, and the maturity would be on April 1, 2034.

From the third to the sixth financial year after opening your account, you can take a loan for up to 25 per cent of your balance two years before the year you wish to borrow. The loan needs to be repaid within three years of taking it. Partial withdrawals are also allowed from the seventh year, subject to limits. Even if interest rates are lowered and yields come down a bit, PPF returns would still compare favourably with most debt funds and bond instruments.

Taxability : The amount invested in PPF is eligible for tax deduction under Section 80C — the accumulated interest and the final maturity amount are both fully exempt from taxes. If the 8 per cent rate sustains, the effective annual yield for a person paying 31.2 per cent tax (30 per cent rate, plus 4 per cent cess) would be around 11.9 per cent, making it a highly attractive option for those in the higher tax slabs.

Employee provident fund (EPF)

Representative image

 

This is probably the most rewarding of all debt instruments. EPF rates are generally set much higher than the 10-year G-Sec yields; tax benefits cover investments and accumulated interest, and there is full safety given the sovereign backing. In a recent announcement, the rate for EPF has been set at a healthy 8.65 per cent for 2018-19. The employee provident fund organisation (EPFO) administers the EPF.

Employers are expected to deduct 12 per cent of an employee’s salary (basic + DA + applicable allowances) for those earning less than ₹15,000. Many employers opt to deduct EPF for those in higher income bracket too. Usually, the employer also matches the employee’s contribution by investing an equal amount (split between EPF and the employee pension scheme). So long as you are employed and even when you switch jobs, avoid the temptation of withdrawing the amount for any other goal or requirement and let the investment compound. Of course, partial withdrawal is allowed for pressing reasons.

You can also step up investments in the provident fund. Called the voluntary provident fund, you can invest up to 100 per cent of your basic and dearness allowance in it. The VPF enjoys the same tax benefits as the EPF.

Taxability : After five continuous years of contribution, EPF becomes tax-free. The amounts invested in EPF are deductible under Section 80C. The accumulated interest and the final corpus are also tax-free.