Pension Plans

A study revealed 51% of its respondents had not started planning for retirement and 89% of its respondents believed that they are unprepared for retirement because they don’t have a secondary income source.

A casual mindset will not prove to be beneficial in the long term. You cannot predict what will happen in the future. Living costs are constantly rising and this is an era of recession, layoffs, and pay cuts.

Even if you retire when you actually meant to, you will need enough money for these incomeless years of your life to take care of daily expenses, utilities, grocery bills, hospital costs, and your bucket list goals. Even if you have savings in the bank, you never know how inflation may rise. Rising costs may eat through savings very fast.

This is precisely why you need to invest in a retirement plan that will take away the stress of meeting expenses during the phase when you’re free from responsibilities and want to relax.

Insurance companies offer various types of retirement plans, based on your current eligibility and return preferences. One such type is a Pension Plan.

Let’s analyse it in detail.
 

What are Pension Plans?

Pension Plans, also known as General Annuity plans, are retirement savings tools that help you generate a steady post-retirement income. They let you accumulate funds over a period of time, which are later converted into guaranteed post-retirement income.
 

How does A Pension Plan Work?

When you purchase a pension plan, the premiums you pay are accumulated into funds for a time span called the ‘accumulation period’. Then, just as you are about to retire, this accumulated amount is converted into a steady income, i.e., an ‘annuity’ that you will receive for a time period specified by you while buying the plan. This is known as the ‘vesting period’ or the ‘payout period’. It can be till the end of your life or for a fixed number of years.

Please Note:

• The premiums that are converted into income will not include rider premiums, extra premiums, and taxes.
• You can customise the frequency of the payouts on a monthly, quarterly, half-yearly, or yearly basis.
   

How is the Annuity Calculated?

The annuity, i.e., the income you receive is calculated on the basis of the annuity rate determined by the insurance company. It is determined at the time of buying the pension plan and remains fixed throughout the plan duration.

The annuity rate is dependent on a number of factors, like the payout period, plan type, your age, etc. The annuity payouts will be calculated on the total premiums paid minus taxes.

Important: As per IRDAI regulations, the annuity amount you receive annually cannot be less than Rs. 12,000.

Example:

Jake, a 45-year-old marketing professional, plans to retire at 60. He wants a secondary income source during his retirement years and decides to invest in a Pension Plan in July 2022.

Let’s assume -

He invests a premium of Rs 1 Lakh (excluding taxes) annually for a 15 years. So, he will have to pay the premiums till he reaches the age of 59 years - till July 2036.

He chooses to receive the annuity payout immediately for a period of 25 years. Thus, he will start getting the annuity payouts from July 2037 - a year after his premium payment term is over.

The annuity rate under the plan is 6%. So,

Annuity Payable To Jake = Total Premiums Paid (excluding taxes) X Annuity Rate

= (1,00,000 X 15 years) X 6%

= 15,00,000 X 6%

= Rs. 90,000

From July 2037 onwards, Jake will receive an annuity of Rs. 90,000 every year for 25 years.
 

Can You Customise A Pension Plan?

Yes, there are a number of customisation options available with a pension plan so you can make it truly yours -

• Premium
  You can configure the premiums you need to pay under the plan. You can either choose the premium amount or choose the annuity amount .

  Choosing the premium amount is a good choice if you have a specific budget you need to stick to. Don’t compromise your present financial security for the future. In this case, the annuity payout will be calculated on the basis of the premiums and the annuity rate.

  Choosing the annuity amount is a good option if you have predetermined future goals that will need to be met by the income you’ll receive. Choosing the annuity amount will, in turn, decide the premiums you will need to pay.

• Payout Commencement Date
  You can also choose when you want to start receiving the payouts. You have two options -

  • Immediate Pension Plan
    The payouts will begin right after the accumulation period is over, i.e., after you finish paying the premiums under the plan.
    So, for instance, if you’re investing in a pension plan for a duration of 15 years, you will receive the annuity once these 15 years are over.

  • Deferred Pension Plan
    You can opt to receive the payouts after a specific period of time, i.e., the deferment period. This is a good choice if you have some time left for retirement. The maximum deferment period may range from 15 to 20 years.
    Suppose you buy the plan at 40 and want to start receiving the annuity from the age of 55 - that is 15 years after buying the plan. In this case, you can choose the deferment period of 15 years. So, the payouts will begin when you turn 55.

• Payout Duration
  Next, you can customise how long you want the annuity. You can choose to receive it -

  • For A Lifetime
    To get annuity payouts till the end of your life, you will have to purchase a Life Pension Plan.
    
    For Example:Amy, a 40-year-old, buys a Pension Plan. She plans on investing Rs. 1.5 Lakhs (excluding taxes) every year for 15 years, i.e., until she turns 55. She wants her annuity payouts to start when she retires - at the age of 55 years. If she chooses a Life Pension Plan, she will receive the annuity payouts for as long as she lives.

  • For A Specific Time Period
    To get annuity payouts for a specific period, say 10 or 20 years, you will have to purchase a Certain Pension Plan.
    
    For Example:Let’s take a look at Amy’s example again and assume that she wants the annuity to be paid till she is 75 years old. In this case, she will have to buy a Certain Pension Plan and customise the payout duration to 20 years.

  • Until A Contingency Occurs
    Some pension plans give you the flexibility of receiving the annuity payouts until a contingency occurs, like a critical illness or disability because of an accident. If this happens, the insurance company will return all the premiums you’ve paid, and then the plan will be terminated.
    
    Note: Insurance companies may continue the annuity even in this case and may increase it by 50%. It will be paid till the end of the payout period you’ve chosen.
    
    For Example:Taking Amy’s example again, let’s assume that she receives a payout of Rs 1 Lakh per year and that the insurance company has already made 7 annuity payouts to her. Amy, in the 8th payout year, is diagnosed with a critical illness listed in her policy wording. As per the policy terms and conditions, the insurance company will increase her annuity by 50% in this case.
    
    So, after the 8th payout year,
    
    Amy’s annuity payout = 1 Lakh + 50% of Lakh every = Rs 1.5 Lakhs.

• Increasing Annuity
  The increasing annuity option is a great way to tackle rising costs and living expenses. The annuity you receive will increase by a set percentage (for instance, 4% or 6%) every year. You are given the flexibility to pick the rate of increase.

  Note: The % may vary across products and insurance companies.

• Picking The Annuitant/s
  An annuitant is the person who receives the payouts under a Pension Plan. You can choose between -

  	Single Life Pension Plan	Joint Life Pension Plan
  What is it?	A single annuitant is covered by the plan, i.e., only you will receive the annuity.	You can add your spouse to this plan. You are the primary annuitant and your spouse is the secondary annuitant.
  How does it work?	Only you receive the annuity when you retire. After you pass away, the annuity stops and the policy ends.	When the primary annuitant passes away, the secondary annuitant continues to receive the annuity. The product you choose determines the amount they’ll receive. It may be either 100% or 50% of the annuity.
  Invest in this plan if -	Your spouse works and your children aren’t financially dependent on you.	Your spouse doesn’t work, or You want to leave behind a legacy for your family

  Now that you’ve understood the various customisation options available with pension plans, let’s have a look at some other important aspects.
   

Death Benefit Under Pension Plans

Whether or not your Pension Plan pays out a death benefit depends on the type of plan you choose. Some plans end after you pass away, while others pay your nominee a death benefit after you pass away.

Note: Some insurance companies may return the premiums or purchase price you’ve paid for the pension plan. This is known as Return of Purchase Price.

In the case of a single-life pension plan, the purchase price is returned when the annuitant passes away. On the other hand, in the case of a joint-life pension plan, the purchase price is returned when the secondary annuitant passes away.

• Term Of Death Benefit
  The term of this death benefit depends on this plan - some might cover the entire accumulation and payout period, and others could cover only a partial period.

• Quantum Of Death Benefit
  The amount your nominee will receive depends on the plan you choose. It may be -

  A percentage of the premiums paid by you. This may range from 50% of the total premiums paid to 110% of the total premiums paid.

  For Example:

  Raymond is a 45-year-old sales rep and plans on retiring when he is 60. He invests in a Pension Plan for 10 years. Let’s assume that he pays a premium of Rs 3 Lakhs (excluding the taxes) and chooses to receive the annuity for lifetime after he reaches the age of 60. And, let’s assume that the applicable annuity rate is 6%.

  Annuity Payable = Total Premiums Paid (excluding taxes) X Annuity Rate

  = (3,00,000 X 10 years) X 7%

  = 30,00,000 X 7%

  = Rs. 2,10,000

  So, Raymond will get an annuity of Rs 2.1 Lakhs every year.

  But, unfortunately, Raymond passes away a few years after his retirement. The insurance company has paid him the annuity for 10 years, and so, they’ve paid him a total of Rs 21 Lakhs.

  He has appointed his 22-year-old son Charles as the nominee.

  Death Benefit = 50% of the Total Premiums Paid

  = 50% X 30,00,000

  = R. 15,00,000

  So, Charles will get Rs 15 Lakhs as the death benefit - and the policy will be terminated.

  If you choose a Certain Annuity Plan and pass away before all the payouts are made, your nominee will be paid the annuity for the rest of the payout period.

  For Example:

  Let’s take a look at Raymond’s example again and assume that he chooses to get the annuity payout for a certain number of years, say, 15 years. So, after he passes away, Charles will continue receiving the annuity of Rs. 2.1 Lakhs for the remaining 4 years.

  Some plans return the balance purchase price to your nominee. This is calculated by deducting the annuity they’ve already paid from the premiums paid by you. The balance amount is given to your nominee.

  For Example:

  Let’s take a look at Raymond’s example again and assume that the balance purchase price is paid to his nominee.

  Balance Purchase Price = Total Premiums Paid (excluding taxes) - Annuity Already Paid

  = 30,00,000 - 21,00,000

  = Rs. 9,00,000

  So, the insurer will pay Rs. 9 Lakhs to Charles as the death benefit and then, the policy will end.

  Note: If the annuity that is already paid out exceeds the premiums you’ve paid, nothing will be returned.
   

Eligibility Criteria For Pension Plans

Here are some important eligibility criteria you must be aware of -

• Entry Age
  This varies across insurers. The minimum entry age can be 18-45 years. And, the maximum entry age can be 65-80 years.

• Annuity Amount
  The IRDAI has stated that the annuity you get every year cannot be less than Rs. 12,000.

• Deferment Period
  As discussed above, the deferment period is the period after you which the annuity payouts will begin under your Pension Plan. The minimum deferment period is the premium payment period you choose. And, the maximum deferment period may range from 15 to 20 years - it will differ across insurance companies.
   

Taxation Rules For Pension Plans

The following tax rules are applicable to Pension Plans -

• During the accumulation period (premium payment term), you can avail of tax benefits of up to Rs. 1.5 Lakhs on the premiums every year - under Section 80C of the Income Tax Act of 1961.
• During the payout period, i.e., when you start receiving the annuity, you won’t get any tax benefits since the annuity is considered as your income. And so, it will be taxable as per your income tax slab.
   

Summing Up!

So, this was all about Pension Plans and how they work. We hope this article helped you understand the various nuances of the features, benefits, eligibility criteria, and taxation rules of these plans.