I am 29 years old and want to plan for my retirement. How good are pension funds compared to public provident funds (PPF)? What are the options available here?
C. Sreedevi, via e-mail
Retirement planning at a young age is always a smart strategy. Time—more than money—is the crucial factor, as the earlier you start charting your investment course, the higher are the returns after retirement. Moreover, retirement benefit products help us in developing a disciplined investment approach for realising future goals.
Both PPF and pension funds have their own advantages. Let us first look at pension schemes. As of today, Indian investors have only two mutual fund pension schemes to pick from: Templeton India Pension Fund (TIPF) and UTI Retirement Benefit Plan (UTI RBUP). These hybrid funds usually have a 60:40 debt-equity allocation. On the other hand, PPF falls under the government's purview. Importantly, what separates the two is that while the rate of return is not guaranteed as far as pension funds go, it is guaranteed in case of PPF (8 per cent a year at present).
Of the two pension funds, TIPF has posted an annualised return of 12.23 per cent since its launch in March 1997, whereas UTI RBP has given out a total return of 8.89 per cent since inception (December 1994), as on February 20, 2003. Thanks to the equity component, pension funds are capable of delivering much higher returns over the long-term. However, there is a downside risk too. If equity markets tank, returns could go for a toss.
As for PPFs, though they are risk-free and enjoys government backing, they don't provide protection against inflation. In the years when inflation is high, the real return on your PPF may be marginal. In that sense pension funds have an edge over PPF as the equity component allows pension funds to beat inflation. That apart, if government reduces interest rates, then new interest rates will apply to your PPF account. Subsequent interest calculations (the interest that an investor earns) will therefore be done on the new rate of interest. However, there is no volatility in returns as PPF has a fixed interest rate—which is not true of pension funds—since returns here are market-determined.
From the tax perspective, both pension funds and PPF are eligible for a tax rebate of 0-20 per cent (depending on the income slab) under Section 88 of the Income Tax Act. To avail this benefit, the total limit for investment under pension fund is Rs 70,000, and for PPF, it is Rs 60,000. A point to note though is that pension funds have a three-year lock-in.
To purchase a pension fund, a minimum investment of Rs 10,000 or installments of at least Rs 500 till the age of 58 (52 years in case of UTI RBP) is needed. There is no upper limit though on investment in a pension fund. But then you will not be entitled for any tax incentive. Once an investor turns 58, he or she can opt for one of the three choices that a pension fund offers: regular income till he or she is alive, partial withdrawal with income on balance units and full withdrawal. On the other hand, the minimum investment in a PPF is Rs 100 per annum and the maximum contribution is Rs 60,000 annually. The duration of a PPF account is 15 financial years. After the expiry of 15 years, it can be extended for another five years.
In PPF, the investment has a lock-in of 15 years, though partial withdrawal is permitted after five years. In comparison, after the three year lock-in period is over, you can redeem your investment from pension funds by paying an exit load. While UTI RBP has a minimum exit load of 5 per cent, TIPF charges a 3 per cent load if units are redeemed before the age of 58. In view of these loads, investment in pension funds should be done after giving it a considerable thought. Though there is liquidity in these schemes a total load of 7 per cent can really dent returns.
In a nutshell, what one expects from any retirement planning tool are mainly two things: safety and growth. Pension funds have the ability to meet both these requirements. While the debt allocation lends stability to the portfolio, an equity allocation helps these funds provide capital appreciation over the long-term. Thus, for investors in your age bracket, pension funds are the perfect option. The only drawback is that there are not too many pension funds to choose from—just two currently. For those in their late 40s, PPF would certainly be a better destination.