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Pension Funds In India – Meaning, Overview, How Do Pension Funds Work, Types, Pension Plan Features & Tax Benefits

Updated on: Jun 20th, 2022


8 min read

Pension plans are a good way to secure your finances post-retirement. In India, there are several pension plans available, and you can choose to invest in the one that you are most comfortable with.

What are pension plans?

Pension plans are also known as retirement plans. In these, you may invest some portion of your income into the designated plans. The main objective behind a pension plan is to have a regular income post-retirement. Given the ever-growing inflation, investing in these plans has become necessary. Therefore, even if you have considerable savings in your bank account, you may still need a pension plan. 

Savings generally get spent on meeting contingent needs. Hence, investing in a pension plan will support you when all other income streams cease to exist. In India, pension plans have two stages – the accumulation stage and the vesting stage. In the former, the investors pay annual premiums until they attain the age of retirement. Then, on reaching the retirement age, the second stage, also known as the vesting stage, would begin. In this stage of the pension plan, the retiree will start receiving annuities until their death or the death of their nominee.   

What are the tax implications of pension plans?

The contributions of up to Rs 1.5 lakh made towards a pension plan under Section 80CCC provide tax deductions. This includes the amount spent on buying a new pension plan or renewing an existing one of similar nature. Both residents and non-residents may claim tax deductions under this section. However, Hindu Undivided Families (HUFs) are not eligible to make such claims under the given section. The withdrawals, however, are not tax-free. Only one-third of the corpus received by the retiree (soon after reaching the retirement age) through the pension plan is tax-free. The rest of the money is paid as an annuity and is subject to taxation. It depends on the retiree’s income tax slab rate.

What are the different types of pension plans available in India?

There are different kinds of pension plans which you can check below:

  • Plans that are sponsored by an insurer where the investment is solely in debt and are best suited for conservative investors.
  • Plans that are unit-linked and invest in both equity and debt.
  • The National Pension Scheme, which invests either 100% in government securities, 100% in debt securities (other than government securities), or a maximum of 75% in equity.

There is no doubt that pension plans are a much safer form of investment with multiple classifications based on the benefits of the plan and its structure.

How are the various plans classified?

The classification of pension funds are made as follows: 

National Pension Scheme

The Government of India introduced a pension scheme in 2004 for those who wanted to build up their pension amount. Your savings will be invested in the debt and equity markets, based on your preference. It allows you to withdraw 60% of the funds at the time of retirement, and the remaining 40% goes towards purchasing an annuity plan. 

Deferred Annuity

With a deferred annuity plan, you can accumulate a corpus through a single premium or regular premiums over the policy term. The pension begins once the policy term gets over. This deferred annuity plan has tax benefits wherein no tax is charged on the money invested until you plan to withdraw it. This scheme can be bought by either making regular contributions or by a one-time payment. This way, it works for you whether you want to invest the entire amount at one time or want to invest systematically.

Pension Funds

The government body, Pension Fund Regulatory and Development Authority (PFRDA), has authorised six companies to operate as fund managers. These plans offer comparatively better returns at the time of maturity and remain in force for a substantial amount of time.

Immediate Annuity

In this type of scheme, the pension begins right away. As soon as you deposit a lump sum amount, your pension starts. This is based on the amount the policyholder invests. You can choose from a range of annuity options. Under the Income Tax Act of 1961, the premiums of the immediate annuity plans are tax exempt. Post the death of the policyholder, it is the nominee who is entitled to the money.

Guaranteed Period Annuity

Regardless of whether the holder survives the duration, this annuity option is given for periods such as five years, ten, fifteen, and twenty years.

Pension Plans with and without cover

Pension plans with cover include life cover, which means that if the policyholder dies, the family members are paid a lump sum. This amount may not be considerable. The without-cover plan, as the name suggests, does not have life cover. If the policyholder passes away, then the nominee gets the corpus. At present, the immediate annuity plans are without protection, while the deferred plans are with cover.

Annuity certain

In this scheme, the annuitant is paid the annuity for a certain number of years. The annuitant can pick this period, and in case of their death, the beneficiary receives the annuity.

Life Annuity

These schemes pay an amount called annuity to the retiree for their lifetime. If the annuitant dies and chooses the option ‘with spouse’, then the spouse receives the pension amount. Want to know more about which pension fund to invest in? 

What are the advantages of pension plans?

Some of the advantages of investing in Pension Plans are listed below:

Option in Investment: 

Pension funds allow investors to invest in either the safe government securities or assume some risk and invest in debt and equity investments, depending on their risk profile. The risk is balanced by the prospect of higher returns that are generated by the investment.

Long-term savings: 

These plans serve as a long-term savings scheme; regardless of whether you opt for lump-sum payments or multiple payments of small amounts, the savings are assured. Pension plans create an annuity that can be invested further and give rise to a steady flow of cash post your retirement.

Choose how you want to get paid: 

Depending on your age or your plans, you can either invest a lump sum amount and get annuity payments right away or choose a deferred annuity plan that will let your corpus earn more interest payouts begin.

Works as a life insurance cover: 

There are pension plans that offer the investor a lump sum amount when they retire or in case of the individual’s death, whichever scenario occurs earlier. This means that your pension policy also serves as a life insurance cover.

Negates the effect of Inflation:

Investing in pension plans is an excellent way to combat inflation. These plans pay a lump sum during your retirement, which amounts to a maximum of one-third of the accumulated corpus, and the remaining two-thirds of the corpus is used in generating a steady cash flow.

Access a lump sum amount during an emergency: 

You are allowed to make adjustments to your pension policy to access a lump sum payout in case of an emergency. This can be done to cover one’s long-term health care.

What are the disadvantages of pension plans?

Limited amount of deduction allowed:

Though pension plans qualify you for a tax deduction, the maximum allowed deduction on life insurance premiums is Rs 1.5 lakh under the Income Tax Act, 1961.

Taxation on the annuity:

When you receive the annuity after your retirement, it is taxable as of that date.

High returns require high-risk taking:

To make sure that the payout at the time of your retirement is adequate, you may have to seek high-risk options to obtain higher returns. The traditional non-risky investment options may not be enough to override the effects of inflation.

Best suited for early investors:

If you are not an early investor, this investment option may be a little late. The returns earned by someone who invests at age 21, as opposed to someone aged 30 or 35 years, will get a substantially more significant return.

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Quick Summary

Pension plans in India offer financial security post-retirement. They involve investing income for regular income later. Tax implications include deductions on contributions. Different types of pension plans vary in investments and benefits. The classification includes National Pension Scheme, Deferred Annuity, Pension Funds, Immediate Annuity, Guaranteed Period Annuity, and others. Advantages include diverse investment options, long-term savings, life insurance, inflation protection, and emergency funds. Disadvantages include limited tax deductions, taxable annuities, need for high-risk investments, and benefits for early investors.

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