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 Retirement Planning - 3 (Traditional Plans) 
Posted By - IndianMoney.com Research Team- On-25/05/09
 
Traditional Pension Plans (Defined benefit pension plan)

 

A Traditional Pension Plan is also known as Defined Benefit Pension Plan. These are the oldest forms ofInsurance Plans available. This is the type of pension plan that your father or grandfather probably had. Your employer puts money aside for you, manages it, and guarantees you a specific amount of money for life upon yourRetirement. The total amount of your pension depends on how long you have worked and how much money you've earned over the years. These plans cater to customers those who like to go with low risk.
 
In other words Pension Plans are non-transparent plans, where the Insurance Company used to invest the fund withGovt. securities of some debt securities, which had very low risk and low return. During retirement the total accumulated fund value along with company declared bonus gets added to the retirement corpus and regular pension are given from this corpus.
 
Features of Traditional Pension Plans
Some of the common features of traditional plans are mentioned below:
 
1.    Major chunk of investible funds are in Debt instruments.
2.    Steady and almost assured returns over the long term.
3.    In most of cases death benefit is Sum Assured + guaranteed & vested bonus.
4.    Helps in asset creation as they are for a long tenure.
5.    Premium to Sum Assured ratios are fixed for each plan and age.
6.    Generally withdrawals are not allowed before maturity.
 
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A traditional Defined Benefit (DB) plan is a plan in which the advantage on retirement is strong-minded by a set formula, rather than depending on investment income. A traditional pension plan that defines an advantage for an employee upon that employee's retirement is a defined benefit plan. Traditionally retirement plans have been administered by institutions which live specifically for that purpose by large businesses or for government workers by the government itself. A traditional form of defined benefit plan is the final salary plan under which the pension paid is equivalent to the number of years worked, multiplied by the member's salary at retirement, multiplied by a factor known as the increase rate. The final accrued amount is available as a monthly pension or a lump sum.
 
The benefit in a Traditional/defined benefit pension plan is strong-minded by a formula that can incorporate the employee's pay, years of employment, age at retirement and other factors. Inflation throughout an employee's retirement affects the purchasing power of the pension. The higher the Inflation rate, the lower the buying power of a fixed annual pension. This effect can be moderated by providing annual increases to the pension at the rate ofInflation (usually capped, for instance at 5% in any given year). This method is advantageous for the employee since it stabilizes the purchasing power of pensions to some extent.
 
If the Pension plan allows for early retirement, payments are frequently reduced to know that the retirees will receive the payouts for longer periods of time. Many Traditional Plans comprise early retirement provisions to encourage employees to retire early, before the achievement of normal retirement age (usually it is 65). Companies would quite hire younger employees at lower wages. Some of those provisions come in the form of additional temporary or supplemental benefits which are payable to a certain age, frequently before attaining normal retirement age.
 
Two types of Traditional Plans
 
1.    Funded Plans
In a funded plan contributions from the employer and sometimes from plan members are invested in a fund towards meeting the benefits. The future returns on the investments and the future benefits to be paid are not known in advance, so there is no assurance that a given level of contributions will be sufficient to meet the benefits. Typically the contributions to be paid are regularly reviewed in a valuation of the plan's assets and liabilities carried out by an actuary to guarantee that the pension fund will meet future payment obligations. This means that in a defined benefit pension, investment risk and investment rewards are classically assumed by the sponsor/employer and not by the individual. If a plan is not well-funded the plan sponsor may not have the monetary resources to continue funding the plan.
 
2.    Unfunded Plans
In an unfunded defined benefit pension no assets are set aside and the profit are paid for by the employer or other pension sponsor as and when they are paid. Pension preparations provided by the state in most countries in the world are unfunded, with benefits paid directly from current workers contributions and taxes. This method of financing is known as Pay-as-you-go.
 
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How do they work?
They regularly begin paying your benefits when you reach retirement age and stop working. Benefits will continue for as long as you live. Most defined benefit plans send you a monthly check. Some give you the option, instead to receive one lump-sum payment when you retire.
 
What is Vesting?
In most defined benefit plans, you should participate for a certain number of years before you have a legal right to receive the benefits, this is called vesting.  In other words the period during which you are paying the premium to the company is called vesting period, after the vesting period you start receiving pension annuity.
 
How long you need to keep yourself insured?
It's significant to ensure that you have sufficient insurance till the time you are the bread-winner. You should insure yourself for as long as you think you would be the crucial bread-winning member of the family. In most cases your insurance cover should have a term that matures when you reach the age of 58-65 years, the age of retirement in most professions. That is the term of your life insurance policy should be from the age you are at hand up to your planned retirement age.
 
For instance, let's assume that you have a family; your spouse and two kids. Your age is 33. You work at a software consulting firm at a salary of Rs. 12 lakh per annum. If you were to take a retirement insurance policy on yourself now, the vesting period of your policy should ideally be 65-33 = 32 years.
 
ULPPs vs. Traditional Retirement Plans
 
        Potential for better returns
        Greater transparency
        Flexibility in investment
        Higher Liquidity (Better exit options):
 
Potential for better returns
Under IRDA guidelines, traditional plans have to invest at least 85% in debt instruments which outcome in low returns. On the other hand, ULIP’s invest in market connected instruments with varying debt and equity proportions and if you wish you can even choose 100% equity option.
 
Greater transparency:
Unlike Ulip’s, in a traditional life insurance policy you are not aware of how your money is invested, where it is invested and what is the value of your investment. But in traditional plan u will be able to know all these details
 
Flexibility in investment:
The top most benefit which Ulip’s offer over traditional plans is the flexibility accessible to you to customize the product according to your needs.
 
  • Flexibility to invest the money the way you want
  • Flexibility to change the fund allocation
  • Flexibility to invest more via top-Ups:
  • Flexibility to skip premium
 
Flexibility to invest the money the way you want
Unlike traditional plans, Ulip’s permit you full discretion to decide the fund alternative most appropriate to your risk appetite.
 
Flexibility to change the fund allocation
Ulip does also give you the option to change the fund allocation at a later stage throughout fund switching facility.
 
Flexibility to invest more via top-Ups
Unlike traditional plans where you have to invest a fixed premium every year, Ulip’s allow you flexibility to invest more than the regular premium via top-ups which are additional investments over and above the regular premium. For the purpose of tax deduction under section 80C, there’s no differentiation between regular premium and top-ups. In other words top-ups are also permitted deduction under section 80C.
 
Flexibility to skip premium
In case of traditional plans, you have to pay premium for the entire duration of the plan. And if by chance you skip even a single premium, your policy lapses. Whereas ULIPs permit you the flexibility to stop paying premium generally after three policy years.  
 
Higher Liquidity (Better exit options)
The possibility to withdraw your money before maturity (through surrender or partial withdrawals) is higher in case of Ulip’s as compared to traditional plans and also the exit costs are lower.
 
Ulip’s are different and of course better than traditional products; however, while in traditional plans your role is a passive one controlled to just making premium payments, Ulip’s need your active involvement. You’ve to make a lot of decisions such as deciding about sum assured and premium to be paid, choosing between type I or type II Ulip making a choice among various fund options available and also deciding about fund switch from time to time based on your needs, risk appetite and market outlook.
 
How much pension do you need?
 
In retirement planning, you need to calculate backward to figure out how much you should invest - with or without tax breaks. First, ask yourself when you wish to retire. Then, what kind of income do you need to maintain your present standard of living.
 
If you think you need Rs 10,000 a month (pre-tax) if you were to retire today, assuming a 6% inflation rate, you would need Rs 17,908 after 10 years, Rs 23,965 after 15 and Rs 32,071 after 20 years. If you assume a more benign inflation rate of, say, 4%, the required amounts would be Rs 14,802, Rs 18,009 and Rs 21,911 after 10, 15 and 20 years of saving.
 
You will then need to talk to your Pension Plan advisor and figure out what you need to put away every year to achieve your targeted pension income. We have to, of course, assume that taxation will be indexed to inflation - in which case your post-tax income 20 years from now will be similar in real terms to what it is today for a pension income of Rs 10,000 per month.
 
Steps involved in determining the requirement for Retirement Plan
 
Step 1: It is very significant to work out the intended expenses after retirement. Planned expenses vary from individual to individual and from one city to another.
 
Step 2:Listing of present wealth and investments gives an indication of the gap accessible between the actual earning potential and the preferred expenditure
 
Step 3:After identifying this gap plan investments hence which take closer to your preferred expenditures
 
Step 4:The risks concerned in these future investments are of fundamental consideration.
 
Step 5: A constant review of available investments helps to mix and match future retirement income plans.
 
Retirement advantage investment plans are offered by banks, non-banking financial institutes and government agencies. In many countries post offices also expand retirement investment plans.
 
Comparison of Traditional Pension Plans
Below given table can help you to make a Comparison between some of the major traditional Pension Plans.

 

 
 
Product Name
 
 
Birla Sun Life Flexi Secure Life Retirement Plan II RP
 
ING Life Golden Life Plan Regular Premium
 
 
Bajaj Allianz Future Secure Plan
 
 
ICICI Life Stage Pension Plan
 
Minimum Premium
 
5,000 p.a.
 
15,000 p.a.
 
6,000 p.a.
 
15,000 p.a.
 
Maximum Premium
 
Information Not Available
No Limit
 
No Limit
 
Information Not Available
 
Minimum Term
 
Information Not Available
Information Not Available
 
5 Years
 
10 Years
 
Maximum Term
 
Information Not Available
Information Not Available
 
40 Years
 
62 Years
 
Minimum age at Entry
 
18 Years
18 Years
 
18 Years
 
18 Years
 
Maximum age at Entry
 
65 Years
65 Years
 
60 years
 
70 Years
 
Vesting Age
 
Minimum it is 50 and Maximum it is 70 Years
Minimum it is 45 Years and Maximum it is 75 Years
 
Minimum it is 40 Years and Maximum it is 70 Years
 
Minimum it is 50 and Maximum it is 80 Years
 
Death Benefit
 
Fund Value
Sum Assured along with the Fund Value
 
Sum Assured along with the Fund Value
 
Fund Value
 
Surrender
 
Can be Surrendered after completion of 3 Policy Year
Can be Surrendered after completion of 3 Policy Year
 
Can be Surrendered after completion of 3 Policy Year
 
Can be Surrendered after completion of 3 Policy Year
 
Top Up option
 
Minimum Top Up will be 10,000
Minimum Top Up will be Rs. 5000
 
Minimum Top Up will be Rs. 5000
 
Minimum Top Up will be Rs. 2000
 
Tax Benefit
 
Tax Benefit is under section 80CCC and 10(10D)
 
Tax Benefit is under section 80CCC
 
Contributions made and proceeds received will be eligible for tax deduction as per applicable tax laws
 
Tax Benefit is under section 80 CCC
 
Top up premium allocation charges
 
1%
2%
 
2%
 
1%
 
Premium Allocation Charges
 
With Out Life Cover - 1st year it is 21.0% and year onwards 2.2%, With Life Cover - 1st year it is 23.0% and 2nd Year onwards 3.7%
If the premium is less than or equal to 5 lacs for 1st year it is 18.0% 2nd year it is 4.5% 3rd to 20th year it is 2% and 21st year onwards it is 1%, If the premium is greater than 5 lacs and less than or equal to 15 lacs 1st year it is 16.5%, 2nd Year it is 4.5%, 3rd to 20th year it is 2% and 21st year onwards 1%, premium greater than 15 lacs 1st year it is 15.0%, 2nd year it is 4.5%, 3rd to 20th year it is 2% and 21st year onwards 1%
 
On 1st year it is 20% and 11th onwards no charges
 
There is no premium allocation charges
 
Fund Management Charges
 
The charge will not exceed 1.5% per annum of the Fund Value
Pension Debt Fund - 0.75%, Pension Equity Fund - 1.50% and Pension Liquid Fund - 0.50%
 
1.75% p.a. of the NAV for Equity Growth Pension Fund and Accelerator Mid-Cap Pension Fund and Pure Stock Pension Fund, 1.25% p.a. of the NAV for Equity Index Pension Fund II and Allocation Pension Fund, 0.95% p.a. of the NAV for Bond Pension Fund and Liquid Pension Fund
 
Pension R.I.C.H. II, Pension Flexi Growth, Pension Flexi Balanced, Pension Multiplier Fund, Pension Balancer - 2.25%, Pension Protector - 1.50%, Pension Preserver - 0.75%
 
Policy Administration Charges
 
Rs. 35 per month
Rs. 50 Per Month
 
Rs. 630 Per Month
 
This charge will be levied only for the first 10 policy years
 
Surrender Charges
 
1st year it is 75%, 2nd year it is 50%, 3rd year it is 25%, 4th year onwards Nil
1st year it is 30%, 2nd Year it is 15%, 3rd Year 10%, 4th Year it is 5%. 5th Year it is 2.5% and 6th year and thereafter 1.0%
 
 Information Not Available
 
3rd Year it is 92%, 4th Year it is 94%, 5th year it is 96%, 6th year it is 98%, 7th to 9th year it is 99%, 10th year onwards it is 100%