Planning ahead

A look at different investments for retirement planning

It is never too soon and never too late to plan for retirement. Even if you are young, in your twenties or your thirties, the fact is that sometime or the other, your productive years are going to come to an end and the regular stream of income that you get either out of your employment or out of your business is going to decline.

When such a time comes, you have to ensure that the standard of living that you and your family are used to is maintained. And if one plans well, the standard of living can even improve!

There are various factors that one has to take into account while planning for retirement. The first and the foremost is the amount of money needed. Secondly, there could be a sudden liquidity requirement.

You may need money to fund your child's education or marriage or even to take care of a sudden illness. In such circumstances your retirement savings should be able to help you meet your needs. Last but not the least, is the tax angle. You don't want the exchequer to gobble up a substantial part of your savings.

Let us start by considering the pension paid by your employer. First, any uncommuted pension (periodic payment) is taxable as salary even if you are no longer an employee of the organisation. However, standard deduction is available up to a maximum of Rs 30,000 when the pension is less than Rs 5 lakh. (Maximum salary beyond which no standard deduction is available).

The commuted value of any pension (lumpsum payment) is fully tax exempt in the hands of a government employee under Section 10(10A)(i). This is so even for a government employee absorbed by a public sector undertaking.

However, for other employees, if they also receive gratuity then one third of the commuted value is exempt and if no gratuity is received then half the commuted value is tax-free.

Where pension is receivable by the spouse upon death of the employee, though it is not a salary, a special deduction of one third of the amount or Rs 15,000, whichever is less, is available.

However, what if your employer does not offer pension? In this case, there is no cause for despair since there are a number of investment products available which can be fashioned into regular pension schemes. Let us see what these are.

There are certain specific schemes of Mutual Funds (MFs) which offer retirement plans. Also, LIC and the current crop of private insurers administer pension plans with various payout options which can be suited to one's needs.

Here the idea is to fund one's own pension during your productive years by contributing during the working life. The premiums paid are deductible under Section 80CCC up to Rs 10,000 per year. This is an income rebate and not a tax rebate. In other words, the amount paid under the plan is directly reduced from one's income chargeable to tax and not from the final tax payable like it is done under Section 88.

Any investment made under Section 80CCC is fully taxable in the hands of the recipient at the completion of the specified time period. In other words, the entire pension received is taxed in the hands of the recipient as income of that year.

In the case of MFs, however, the tax laws are slightly different. Here, a tax rebate is available under Section 88 up to 20 per cent of the contributed amount. Also, since the contribution is made under Section 88, the overall section limit of Rs 70,000 is applicable. (These are not ELSS schemes where the limit for tax rebate is Rs 10,000).

The way these plans work is under the framework of a normal MF scheme, where for every contribution, units are allotted. Upon attaining a certain age (58 years), you can apply for pension payments in the form of either a regular monthly income or a lumpsum or any combination of the two. Depending upon the amount desired, the appropriate number of units are redeemed.

The advantage here is that instead of the total withdrawn amount being fully taxable, long-term capital gains system applies where only the gain portion is taxable at 10 per cent without indexation or 20 per cent with indexation. Since the holding period is quite long, indexation ends up in reducing the tax outgo substantially.

The other thing to note here is that the limit mentioned is just for availing of the tax benefit. However, one may invest more if one so desires.

We have covered instruments expressly launched as pension products. However, this is not all. In addition we can use available investment and insurance products to tailor-make our own pension schemes.

For example, a regular MF income scheme that does not lock-in your funds till a pre-determined time may be used to achieve the same effect. Money compounded will grow likewise regardless of the scheme that you will invest in. But if the fact that returns from an MF being not certain is proving to be a hurdle, you may consider investing partly in RBI Relief Bonds (6.5 per cent tax-free or 8 per cent taxable depending upon your slab) or in NSCs or even in PPF.

Incidentally, the lock-in for PPF is six years and not fifteen as many believe. One can save money in these schemes at regular intervals during the pre-retirement years and withdraw regularly during retirement. Take care to consider taxability though as PPF proceeds are totally tax-free whereas NSC income is taxable with the associated 80L benefit.

Last but not least, one can also take advantage of the plethora of endowment and money-back policies available from LIC and private insurers for fine tuning periodic lumpsum requirements.

We have covered the entire gamut of investment options that are either directly available or can be fashioned into pension flows. Which ones to use and the strategy to adopt would depend upon your specific requirements. Generally a combination of an annuity, periodic payments and a lumpsum receivable is the optimum mix.

One instrument rather conspicuous by its absence is equity. This is for the express reason that equity and equity related instruments, while having the potential to earn handsome returns, have to be used wisely.

And the wisest thing that you can do is not taking equity exposure for your retirement savings. Today the markets are vibrant and there is money to be made. As tempting as it may look, the stock market is the last place you should choose to invest what would be your safety net in retirement.

The author may be contacted at anshanbhag@yahoo.com