Retirement planning is one of the crucial aspects of one's overall investment planning. After all, pension will become your sole source of income post retirement. And the early you start charting your investment course, higher will be the returns post-retirement (via power of compounding). Broadly, there are three types of investment avenues for retirement planning, which entails tax benefit — PPF, pension plans of mutual funds and pension plans of life insurance companies.
Investments of up to Rs 70,000 in both PPF and pension plans of mutual funds is liable for tax benefit under Section 88 of the Income Tax Act, 1961. On the other hand, investment in pension plans of insurance companies entail a deduction of up to Rs 10,000 every year from your taxable income under Section 80CCC on the premium paid.
Pension Funds - A Primer
Pension plans of mutual funds have largely remained out of the investors' investment universe because of low popularity and scarcity of funds. There are currently two such funds in operation in India — Templeton India Pension Plan and UTI Retirement Benefit Plan. But, these funds are an attractive investment vehicle for building up retirement savings, mainly because of their automatic re-balancing feature and tax-efficiency. Introduced for the first time in December 1994, pension funds are hybrid schemes, which have a debt orientation. Generally, they maintain a 60-40 debt-equity allocation at all times, thus, reducing your headache of consistent re-balancing of portfolio.
In the past five years, Templeton India Pension Plan has given an annualised return of 16 per cent and UTI Retirement Benefit Plan has delivered 10.73 per cent return, as on February 26, 2004, which is better than what PPF currently offers (guaranteed return of 8 per cent). 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. But a higher debt allocation acts as a buffer. Moreover, the long-term nature of the pension funds would take care of the intermittent volatility. Just like tax-planning equity funds, these pension funds also have a lock-in of three years. However, after expiry of three years, you can redeem your investment from pension funds by paying an exit load. While UTI Retirement Benefit Plan has a minimum exit load of 1 per cent, Templeton India Pension Plan 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 over 4 per cent (entry and exit load combined) can really dent returns. Generally, one expects mainly two things from any retirement planning tool: 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 any individual, pension funds are the perfect retirement-planning tool. Further, tax-efficiency is an added advantage. The only drawback is that there are not too many pension funds to choose from—just two currently. Let's take a closer look at each of them separately.
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Templeton India Pension Plan
Templeton India Pension Plan is the better of the two existing pension funds. In nearly seven years of its operation, this fund has delivered a total annualised return of 15.97 per cent as on February 26, 2004. That apart, the returns have come with low volatility thus making it a good tax-saving investment.
The fund has consistently maintained a 60-40 debt-equity allocation in recent past, thus sticking to its investment mandate. Though debt forms a large part of the portfolio, but the fund manager has managed the fund very cautiously, without taking a big call on the interest rate. For instance, its average maturity has been in the lower band of 0.57-3.64 years. Even during the bank rate cuts in the past three years, the fund kept its average maturity at around 2 years. Rational: the fund is meant to meet investors' post-retirement needs, thus the fund managers can't take higher risks.
Moreover, the fund has largely stuck to quality bonds (AAA-rated) and gilts have accounted for an average 9 per cent of the portfolio. However, in the past three months, the fund has pared all its gilt holdings in favour of AAA-rated bonds. Though initially, it was not that much quality cautious.
In 2000, exposure to below AAA rated bonds accounted for an average 18 per cent, but that too has come down to 8 per cent in 2003. The biggest advantage for the fund managers of pension fund is that the 3-year lock-in gives them enough liberty to buy and hold a particular bond till maturity. This helps in earning continuous higher interest without bothering about the market yields. For example, Templeton India Pension fund is holding debentures of IDBI for the last five years. It has also held the debentures of Reliance Industries for five years.
The fund mangers' low risk proposition can also be seen from the fact that for the initial three years, it didn't take any exposure to equities. Thus, the fund remained unscathed when the tech stocks crashed post March 2000.
It started investing in equities since May 2000 and that too in large-cap stocks. Infosys, Hindalco, BPCL and HDFC Bank have been the fund's top holdings for long. Overall, the equity portfolio has always been widely diversified and spread over 15-20 stocks. In 2003, the fund had a higher exposure in financial services sector, which was one of the best performing sectors that year and the fund gained 42 per cent in 2003.
To purchase Templeton India Pension Plan, a minimum investment of Rs 500 is needed. The fund also offers Systematic Investment Plan, for which the minimum investment amount is Rs 500 per month for 12 months or Rs 1,000 per month for 6 months. Once an investor turns 58, he or she can opt for the full redemption or Systematic Withdrawal Plan (SWP).
UTI Retirement Benefit Plan
This fund is the oldest and largest of the two pension funds. Launched in December 1994, UTI Retirement Benefit Plan has delivered a total annualised return of 10.88 per cent, as on February 26, 2004. This can be considered a decent performance withstanding the ups and downs that both debt and equity markets have gone through in the past nine years.
In recent years, the fund manger has maintained a cautious investment approach. He has relied heavily on the fixed income side - debt holdings account for an average 75 per cent of the portfolio. Moreover, to reap greater benefit, the fund manager had maintained a higher exposure in below AAA rated bonds (average 25 per cent). Gilts, on the other hand, have accounted for an average 6 per cent of the portfolio. The fund's average maturity has also been in the range of 3.2-4.64 years, thus consistently benefiting from the declining interest rate.
Historically, the fund hasn't been as conservative as it is today. During the tech boom, the fund's equity exposure went as high as 73 per cent of the portfolio. But as the fund has always maintained a well-diversified portfolio, the loss was not too heartening. Generally, UTI Retirement Benefit Plan's equity portfolio has been spread over 40-60 stocks with no concentration in any select sector. Even at the peak of 2000 rally, it had investments in 34 stocks spread over various sectors. Thus, it ended the year 2000 with a marginal loss of 3.64 per cent.
But since then, the fund has never gone heavy on equities. Even in 2003, when equity markets were on a roll, the fund had an average 25 per cent exposure in equities. And as 2003 was not so good for the debt market, UTI Retirement Benefit Plan just managed to gain 29 per cent.
After learning from the past mistakes, the current portfolio of UTI Retirement Benefit Plan looks well-balanced (60-40 debt-equity exposure). Thus, this fund could be considered as a good retirement planning fund, which also entails tax-benefit to the investor.
For investing in UTI Retirement Benefit Plan, a minimum investment of Rs 10,000 or instalments of at least Rs 500 till the age of 52 years is required. There is no upper limit 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: regular income till he or she is alive, partial withdrawal with income on balance units and full withdrawal.
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