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 Retirement Planning - 2 (Unit Linked Pension Plans) 
Posted By - IndianMoney.com Research Team- On-11/05/09
 
The whole idea behind retirement planning is to set aside a portion of your regular income in a disciplined manner which gets accumulated, during your working years, to provide for your retirement needs. Pension products, on the other hand, have undergone a transformation post liberalization of the insurance industry. Insurance companiesoffer two kinds of pension plans, such as;
 
  •       Traditional Plans
  •       Unit Linked Plans 
Traditional pension plans normally, are not a good idea because they primarily invest in Fixed Income Securities. The returns are very low, and charges are high. No doubt they are relatively safe; however they invest money in low yield securities that hardly ever beat inflation. Eventually, private insurers started offering Unit Linked Pension Plan (ULPP), thus, opening an attractive avenue for investors to invest their long-term money in.
 
The first point to note is that there is no insurance in an ULPP, though the product is offered by insurers. Even if an insurer offers insurance cover bundled with pension, such a product is best avoided. Insurance is best taken independently from pension planning, through what are called term insurance plans. ULPP is very much an investment product, competing on costs, benefits and returns with Mutual Funds, deposits, share portfolios, and so on. In the accumulation phase, the amounts invested go towards purchase of units, at prevailing market rates. At retirement, the policyholder is provided with a certain portion of the accumulated fund as a lump sum payment. The remaining amount is used to purchase an Annuity scheme to provide regular monthly income post retirement.
 
In reality, ULPPs have several advantages over mutual funds and stock portfolios. They bring about discipline and regularity of investing. Investors are less likely to view and mix their portfolio frequently, unlike what happens with funds. They can enjoy Tax benefits – while contributions fall under Section 80C, the proceeds are Tax free under Section 10(10) D. ULPPs, in the past, have been bad for investors, due to their extremely high cost structure, and due to mis-selling by wrongly informed agents getting high commissions. First year commissions were high and have often eaten away any potential gains for the investor from equity upside. However, this is changing now in the wake of investors’ growing awareness and the industry’s maturity. There are significant differences in charges between different policies. An unbiased financial advisor is best placed to analyze the one best suit for you, after taking into account the size of the required corpus/return, the duration and other features are desired. In almost all policies, costs are largely recovered upfront. Thus, once you enter a policy, it makes sense to stick with that particular policy for at least a decade. Churning of policies is extremely expensive and counterproductive – it defeats the entire purpose of a ULPP.
 
The whole idea of ULPP is to invest regularly and forget – not falling into the trap of micro-managing investment. Switching after three years is the worst thing you can do – since all costs are front loaded. To be very clear, all the charges in ULPPs are charged in the initial years i.e.; in the first three years. So it will be foolishness if you are switching from the policy after this period. Because in the new plan again you have to pay all these charges, so it is better to continue with a particular plan. The investment risk is to be borne by the investor in ULPP, so the expected retirement corpus is totally dependent on the fund managers’ ability to manage the portfolio. It is, therefore, important to consider the track record of the fund manager before investing.
 
Retirement is the end of active employment and brings with it the termination of regular income. Today an increasing number of people have confirmed planning for their retirement for below mentioned reasons
 
  • Approximately 96% of the working population has no formal provisions for retirement
  •  With the growing nuclearisation of family structure, traditional support system of the younger earning members – is no longer available
  • Developments in the healthcare space has guide to an increase in life expectancy.
  • Cost of living is increasing at an alarming rate 
Pension plans from insurance companies guarantee that regular, disciplined savings in such plans can build up over a period of time to provide a stable income post-retirement. Usually all Retirement Plans have two distinctive phases
 
  • The accumulation phase when you are saving and investing throughout your earning years to build up a retirement corpus and
  • The withdrawal phase when you really collect the benefits of your investment as your annuity payouts begin.

     

In a typical pension plan you have the suppleness to make a lump sum payment or a regular payment every year during your earning years. Your money is then invested in funds of your choice. You can opt to receive the allowance at any time after vesting age (age at which you become eligible for pension chosen by you at the inception of the plan).In a retirement plan the earlier you begin the better you gain post retirement due to the power of compounding.
 
How the fund grows in ULPP?
Let us take an example of Raj & Hari. Both of them want to retire at the age of 60. Raj starts investing Rs. 10,000 every year from the age of 25 till the time that he retires. In all, he would have invested Rs. 350,000. If his investments were to earn 7% return every year, at the time of his retirement, Raj will have a retirement corpus of Rs. 13, 82,368.
 
Now Hari starts investing 10 years later (i.e. at the age of 35) and in order to make up for the lost time, he invests Rs.15, 000 every year (which is 50% more than raj’s annual investment). So, by the time of his retirement, he would have invested Rs. 3, 75, 000. And assuming the same annual return of 7% he will end up with a retirement corpus of Rs 9, 48,735.
 
Most of the Unit linked pension plans also come with a broad range of annuity options which gives you choice in structuring the post-retirement benefit pay-outs. Also at the time of vesting you can make a lump sum tax-exempted withdrawal of up to 33 per cent of the accumulated corpus.
 
Options available to individuals on pension plans
Pension plans come with various annuity options. We have explained them below:
 
  •       Lifetime annuity without return of purchase price
  •       Annuity for life with a return of the purchase price
  •       Lifetime annuity guaranteed for a certain number of years
  •       Joint life/ Last survivor annuity
 
Lifetime annuity without return of purchase price:
Under this kind of plan the individual receives pension for as long as he lives. The pension ceases on occurrence of an eventuality and the insurance contract comes to an end.
 
Annuity for life with a return of the purchase price:
If this option is exercised the individual receives pension till he is alive. In the event of an eventuality the purchase price of the annuity is paid out to his nominees or beneficiaries. Purchase price means the maturity amount which includes the basic sum assured plus the bonuses or additions, if any.
 
Lifetime annuity guaranteed for a certain number of years:
Under this option the individual receives a pension for a certain number of years as prescribed by the plan irrespective of whether he is alive for the said period or not. A major positive of this option is that, if he survives the period he continues to receive pension for the rest of his life.
 
Joint life/ Last survivor annuity:
Here the individual receives a pension till he is alive. In case of an eventuality, his spouse receives the pension.
 
How to Choose ULPP plans
Following are the factors to be considered before choosing a ULPP
 
  •           Understand the concept of ULPPs thoroughly
  •           Focus on your requirements and risk profile
  •           Understand the peculiarities of the plan
  •           Examine the performance of the plan
  •           Understand the charges levied on the product
  •           Compare ULPP products of different insurance companies
  •            Know about the Company 
Benefits of the ULIP Pension Plans    
  •        Flexible Life Cover
  •        Flexible Investment Options
  •        Regular income through systematic withdrawal benefit after retirement.
 
Working of Unit Linked Pension Plans
We can start this discussion by taking an example; an individual aged 30 years who wants to buy a pension plan with a sum assured of Rs 500,000 for 30-year tenure. The premium to be paid for the same is approximately Rs 13,500. In case of an eventuality, the beneficiary will stand to get the sum assured of Rs 500,000 plus the bonuses/additions, if any. With the help of
Below given table we can understand the facts clearly.
 

 

Age
(Yrs)
Sum assured
Rs
Tenure
(Yrs)
Annual premium
Rs
Maturity amt
(6%)
Rs
Maturity Amt (10%)
Rs
30
5,00,000
30
13,500
960,000
1,590,500

 

 

 

 

 

Actual rate of return
5.10% (for 6% figure)*
7.80% (for 10% figure)*
Annuity amt(Rs)
71,500
118,500

 

 
*5.10% will be the actual rate of return for an offered rate of 6%
*7.80% will be the actual rate of return for an offered rate of 10%
 
In case the individual survives the tenure, he will stand to benefit to the tune of the maturity amount as indicated in the table below. Assuming that he buys an annuity for life, the annual amount he would get as pension would be approximately Rs 71,500 (on Rs 960,000) or Rs 118,500 (on Rs 15, 90,500). The option of receiving monthly/quarterly/half-yearly pension is available with most life insurance companies.
 
However, the returns shown at 6% and 10% are not calculated on the premium paid. They are calculated after deducting expenses from the premium. The actual Compounded Annual Growth Rate (CAGR) on the premium works out to approximately 5.10% (for the 6% figure) or 7.80% (for the 10% figure).
 
Difference between Conventional Life Insurance plans and Unit Linked Pension Plans
There are some basic differences between life insurance plans and pension plans with the objective behind both of them being the most important. Life insurance plans aim at covering the risk from an unfortunate event. Pension plans on the other hand work on the opposite scenario that if an individual survives beyond an age (retirement age) and he need to provide for him.
 
The difference in objectives is the main reason for the differences in the features of life insurance and pension plans. Following are the major difference between Traditional plans and Pension Plans.
 

 

Features
Traditional plan
Pension plan
 
Maturity benefit
Full maturity amount received by the individual
Only up to one-third of the maturity amt can be withdrawn. Remaining 2/3rd amt are to be compulsorily invested in an annuity.
 
Death benefit
Full maturity amount received by the nominees/ beneficiaries
Nominees/ beneficiaries have the option of receiving the entire maturity amt or investing up to 2/3rd of the amt in an annuity.
 
Tax benefit
Deduction up to Rs 100,000 available under Section 80C
 
Deduction up to Rs 10,000 available under Section 80CCC.
 
Taxation of maturity payouts
Entire maturity amt treated as tax free in the hands of the receiver
Up to 1/3rd of the maturity amt, if withdrawn, is treated as tax-free. Pension received on the remaining 2/3rd amt is taxed as per the individual's tax slab
 
Stream of income
Entire maturity amt/ death benefit received in one go. No provision for a stream of income by way of pension.
 
On maturity, provides for a regular stream of income. In case of an eventuality, option of pension benefits available

 

 
Why Unit Linked Pension Plans are better than Mutual Funds?
You might be having the doubt where to invest - pensions plan or mutual funds? Here are some of the details whyPension Plans are better than mutual funds.
Let us compare both the plans with the help of following example;
 
  • The client's age is 38 years and he would like to retire 22 years hence i.e. at the age of 60 years.
  • The client would like to invest an amount of Rs 10, 00,000 (Rs 10 lakh) each year for three years. In total he will invest an amount of Rs 30 lakh over 3 years.
  • The client has been suggested a single premium plan of Rs 1 m with additional top-ups worth Rs 1 m p.a. (per annum) for the following two years. In all, the client would be paying Rs 3 m over the 3-yr period.
  • The client has a high-risk appetite and would like to remain invested in equities throughout the tenure of the pension plan.
  • The client has a well-diversified portfolio including mutual funds and stocks 
Based on the information we will show likely retirement solution for the investor. It will help you to make an understanding about the working of Pension Plans and Mutual Funds.
 
How do Pension Funds work?
 

 

Investment amt(Rs)
One-time
charge (%)
Administration Charges (Rs)
Fund Management
Charges (%)
Investment Tenure (Years)
1,000,000
2.50
180
0.80
22
1,000,000
2.50
180
0.80
21
1,000,000
1.00
180
0.80
20

 

 

If the customer decides to buy the pension plan then he would be paying Rs 10, 00,000 in the first year. Since this is a single premium plan, one-time charges on the same are 2.50% (i.e. in the first year). In other words Rs 25,000 would be deducted from the client's single premium amount and the remaining amount (i.e. Rs 9, 75,000) would be invested in the 100% equity ULPP option. This amount will remain invested for the entire 22-yr tenure. The charges for any additional top-ups in the second year too would be to the tune of 2.50%. Similar to the first year Rs 25,000 would be deducted from the second year's top-up amount. So Rs. 975,000 would be invested over 21 years.
 
One-time charges for any top-ups from the third year onwards fall to 1% for the year. Thus, only Rs 10,000 (i.e. 1% of Rs 1,000,000) would be deducted and the outstanding amount would be invested. The third year amount (Rs 990,000) will remain invested for a 20-yr period (i.e. time to maturity). Fund management charges (FMC) for managing equities in the given ULPP are 0.80% p.a. Administration charges are assumed to be Rs 180 p.a. (increasing at an assumed inflation rate of 5.00%).
 
As can be seen from the table above, assuming a compounded growth rate (CAGR) of 10% p.a. over 22-Yr tenure, the client's investments will grow to approximately Rs 18,400,000.
 
How do Mutual Funds work? 

 

Investment
amt (Rs)
Entry load 
(%)
Fund Management
Charges (%)
Investment
Tenure (Years)
10,00,000
2.25
2.00
22
10,00,000
2.25
2.00
21
10,00,000
2.25
2.00
20

 

 
The client will invest Rs 10,00,000 p.a. for 3 years in a mutual fund scheme. However unlike a one-time initial charge associated with the ULPP above mutual funds usually have an entry or exit load on their schemes. Assuming an entry load of 2.25% for each of his three annual investments (of Rs 1,000,000), the net amount invested would be drawn down by Rs 22,500 (i.e. 2.25% of Rs 1,000,000) each year for the initial three years.
 
We have also assumed a decreasing FMC (Fund Management Charges) on the mutual fund schemes- the assumption here is it would be 2.00% for the first 5 years, 1.75% for the next 5 years and 1.50% for the remaining period thereafter. The declining FMC assumption is based on the fact that as the quantity for a mutual fund scheme grows over a period of time, economies of scale come into play. This helps the mutual fund spread its costs over a larger quantity thereby reducing its overall cost of managing the fund.
 
As with the Pension Plan assuming a 10% rate of growth over a 22-yr period, the mutual fund investments would have grown to approximately Rs 1,5240,000. The return generated by ULPP is higher than the mutual fund return by Rs 31,60,000 (i.e. 20.73%).
 
The reason why Pension Plan scores over mutual funds is because of a low FMC. The FMC on the Pension Plan under review is 0.80% throughout the tenure as compared to the mutual fund FMC, which is in the 1.50%-2.00% range. Over the long term FMC makes a significant impact by reducing the corpus available for investments. In other words, lower the FMC, higher the investible surplus and vice-versa.
 
Entry load
It is the commission that an investor has to pay while purchasing units of a mutual fund. This is a certain percentage that the mutual fund charges to meet its expenses. Certain funds have Exit Load which means a similar kind of commission but it is charged when the investor exits the scheme.
Therefore it is better to invest your money in the Pension Plans than mutual funds
 
Comparison of ULPPs :
The below given table will help you to compare some of the Unit Linked Pension Plans in the market.
 
Product Name
Birla Sun Life Insurance Freedom 58
HDFC Life Unit Linked Pension II
ICICI Life Link Super Pension Plan
Canara HSBC Unit Linked Pension Plan SP
Minimum Premium
 10,000
Rs. 12,000
 25,000
Rs. 50,000
Maximum Premium
Information Not Available
No Limit
No Limit
No Limit
Minimum Term
 5 Years
 10 Years
 5 Years
5 Years
Maximum Term
 Not Applicable
40 Years
57 Years
 52 Years
Minimum age at Entry
 18 Years
18 Years
18 Years
18 Years
Maximum age at Entry
 80 Years
65 Years
70 Years
65 Years
Vesting Age
 Not Applicable
Minimum is 50 Years and Maximum is 75 Years
 
Minimum it is 45 Years and Maximum it is 75 Years
Minimum Age is 45 Years and Maximum age is 70 Years
Death Benefit
 Fund Value
 Fund Value
 Fund Value
Sum Assured along with the 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 10,000
Information Not Available
Minimum Top Up will be Rs. 5000
Tax Benefit
 Tax Benefit is under section 80CCC and 10(10A)
 Tax Benefit is under Section 80CCC
Information Not Available
 
Contributions made and proceeds received will be eligible for tax deduction as per applicable tax laws
Top up premium allocation charges
 2%
1st year it is 2.5%, 2nd year onwards it is 2%
Information Not Available
2%
Premium Allocation Charges
 1st year it is 10%, 2nd year onwards 2%
 
Annualised Regular Premium - 1st year for the premium of 12,000 to 4,99,999 the charges will be 60%, for 5,00,000 and above the charges will be 80%, Annualised Regular Premium for 2nd year the charges will be 85%, Annualised Regular Premium from 3rd policy year onwards the charges will be 98%
 This will be deducted from the premium amount at the time of premium payment and units will be allocated thereafter
On 1st year it is 20% and 11th onwards no charges
Fund Management Charges
 1.00% for Income Advantage, Protector, Buider and Enhancer, 1.25% for Maximiser
 In the long term, the key to building great maturity value is a low FMC. The daily unit price already includes our low fund managment charge of only 1.25% per annum charged daily, of the fund's value.
 Pension R.I.C.H. II, Pension Flexi Growth II, Pension Multiplier II - 1.50%, Pension Flexi Balanced II, Pension Balancer Fund II - 1.00%, Pension Protector II, Pension Preserver - 0.75%
 
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
Policy Administration Charges
 5% per annum since inception
Rs. 60 per month will be charged
Rs. 20 Per Month
Rs. 630 Per Month
Surrender Charges
 1st year it is 27%, 2nd Year it is 20%, 3rd Year it is 13% and 4th year on wards No Charges
 
4th policy year it is 95% of the fund value, 3rd policy year it is 35% of the fund value, 2nd policy year it is 15% of the fund value, 1st year it is 5% of the fund value. 0 - Nil
3rd year it is 96%, 4th year it is 98%, 5th and above it is 100%
Information Not Available
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

We believe that the

information provided in this article is informative for you. Apart from Unit Linked Pension Plans (ULPP), many other avenues are also available to park your savings and it can help you in making a good money backup for your retirement needs. In our next article we will discuss about Traditional Retirement Plans. We hope it will help you to enhance your knowledge about the importance of Retirement planning.