Planning for sunset years at young age is a smart step. Pension funds can be of help here. Fund managers avoid illiquid stocks. They are difficult to buy and sell and price discovery is not easy
I am 29 years old and want to plan for my retirement. How good are pension funds compared to public provident funds (PPF)?
Retirement planning at a young age is always a smart strategy, as the earlier you start charting your investment course, the higher are the returns after retirement.
Apart from PPF and pension funds, you could look at pension plans floated by insurance companies, with an optional insurance cover. There are only two mutual fund pension schemes to pick from: Templeton India Pension Fund (TIPF) and UTI Retirement Benefit Plan (UTI RBP). These hybrid funds usually have a 60:40 debt-equity allocation, while insurance pension plans offer equity exposure up to 100 per cent (under certain plans). On the other hand, PPF falls under the government's purview. Unlike PPF, the rate of return is not guaranteed in case of pension funds and insurance pension plans.
Of the two pension funds, TIPF posted an annualised return of 16.31 per cent since its launch in March 1997, whereas UTI RBP has returned 11.84 per cent since inception (December 1994), as on February 19, 2007. Thanks to the equity component, pension funds and insurance pension plans 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 enjoy 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. From the tax perspective, the three instruments are eligible for a tax rebate under Section 80c of the Income Tax Act.
PPF investments carry 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 of 1 per cent for in case of UTI RBP, and 3 per cent in case of TIPF if units are redeemed before the age of 58. In case of insurance pension plans redemptions after the three year lock in period are subject to a surrender charge which vary based on the insurance company and the plan. In a nutshell, what one expects from any retirement planning is safety and growth. Pension funds have the ability to meet both these requirements through their balanced asset allocation. Thus, for investors in your age bracket, pension funds from mutual funds or insurance companies are the better option.
Fund managers have limitations, hence, they cannot look at illiquid stocks but ordinary investors can invest in such shares. Is it better to avoid mutual funds in such a situation?
Fund managers definitely have limitations in buying illiquid securities. SEBI regulations stipulate that illiquid securities should not form more than 5 per cent of a fund's portfolio. The fund managers avoid illiquid shares, as these stocks are difficult to buy as well as sell and such a lack of liquidity does not allow price discovery. Also from a fund manager's point of view, it is always safe to buy large and well-known scrips. As the saying goes, 'No one ever got fired for owning Hindustan Lever'. A contrasting viewpoint is that liquidity is a function of interest. If there is no interest in a stock, then trading will be minimal. However, the biggest reward from the market comes from discovering such stocks. If a stock's fundamentals are sound, then it is a scrip waiting to be discovered. And, whoever enters the stock first will most likely derive the maximum benefit. But you must conduct a lot of research while picking such stocks. If you have the time, inclination and enough understanding of the market, you can consider investing in them on your own. But they should not account for a large part of your portfolio.
I am planning to invest in liquid funds. As short-term gains tax is as high as 30 per cent, how can I redeem my gains in a tax-efficient manner?
You are right. If you redeem your units, it would prove painful because your profits will be clubbed together with your other income and you will be taxed at the marginal rate, which could be as high as 30 per cent.
But there is a way out. You can opt for the dividend option, which is a more tax-efficient method of receiving returns from a liquid fund provided you are in the highest tax bracket. The only tax you pay here will be the dividend distribution tax (DDT) of 25 per cent (plus cess and surcharge). Within the dividend option, most funds have an option of daily or weekly dividends. Most of the gains are paid out through these dividends. As the frequency of dividend payout is high, the NAV movement looks like a saw tooth moving within a narrow band close to the face value. Until the recent budget DDT was at 12.5 per cent making the dividend option extremely attractive. But then one should not worry on this aspect as the alternatives such as the interest on short-term bank deposits is also taxed at the same rate. At the end of the day there is no getting away from paying tax.