Why You should not Opt for a Readymade Pension Plan
Perils of pension or annuity plans, or retirement plan mutual funds.
One of my friends recently met a smart young supposedly “IRDA approved financial consultant” who gave him an overview of investing into a retirement plan (and which was not a Ulip, in his words). I was merely an observer.
He gave him nice descriptions about the plan, and how that will be the best thing for his retirement and how he can then enjoy the best things in life automatically (only and only) if he invests in that plan. Awesome idea. Their fund management team had worked fabulously, and provided 15% returns on balanced funds (balanced funds = funds which can invest in both equities and debt). And implied in the response was that they will continue to do that for all the coming years. Great thing indeed again.
My friend asked “How much will this cost to me?”. Sir, around 2.5% are the total management charges. Hmm. That sounds decent.
Next question “How much will I have to invest?”. Sir, if you can tell us how much will you need, then we can tell you. Or you can mail us directly about that and we can get back to you with specific numbers. Fair enough.
After the talk, my friend asked for the brochure, and asked them to wait for his call after a week. In any investment plan, delay the hurry.
So here comes my analysis from the Brochure.
“In this policy, the investment risk in Investment Portfolio is Borne by the Policyholder”. In big bright bold letters. Inf= Ok. Good, they had told him but with an oral implication of 15% returns.
Then comes a slew of good things and offers. Blah Blah.
“In this plan, your premium, net of premium allocation charges, will be invested in an exclusive Pension Fund. At the end of the policy term, you will receive higher of the following – Fund Value or Assured Benefit of 101% of all premiums (including top-up premiums). Inf= So, the guarantee is what one pays over all the years. And they will add 1% to the total principal and return it as the guarantee. Even this is not free and comes with its own charge.
Your maturity benefit will be used to provide you with post-retirement income i.e. an annuity which you have to purchase from us. Oh. The advisors had already told him that he can get UPTO 33% of that amount as cash, while rest has to be used for annuity or have to pay tax on that.
If there is unfortunate demise of the policyholder, then the nominee will get the death benefit. This is Higher of 1. Fund value or 2. Total premiums paid plus interest @ 6% per year. And of course, if the fund value is less than the alternative total value, then the company will deduct mortality charges, based upon the age of the policy holder (more the age, more will be the mortality charges).
Then there is a slew of different options, most of which I do not think I have any idea. Eg:
- 1.Plan your maturity age. How is one supposed to plan the retirement age, will it be 55,60,65 or 70.
- 2.Retirement needs. Which are extremely difficult to assess. Too many variables.
Investment Fund- The fund in this case is a single fund, which is a balanced fund with a max of equity of 60%. Actually, this is not a bad option for a short-to-medium term (say 8-10 years). But for a period of 20-30 years, this restriction is a bad option.
There is no information regarding the investment team (who are they, how many, how long is their experience, etc. How has the performance been).
Then there are standard clauses regarding the investment fund and benefits (which I have already enumerated above). One important thing is again, the investment risk is borne by the policyholder (which means, if the fund value goes down, ultimately it is the policy holder's responsibility only).
Some special considerations:
Policy Discontinuance- Upto 5 years, if the policy is not paid continuously, the money will get transferred to a Discontinued Policy fund, which will get a princely savings account interest rate of the biggest bank of India (SBI) – currently 4% - minus the discontinued policy fund charge of 0.5%. Amazing.
After 5 years, if one does not pay, then it will get an automatic surrender and the fund value will be paid back.
At Maturity: Apart from 1/3 of the fund value taxfree cash, I will HAVE to buy an annuity from this company (or probably from other companies too). The various annuity plans have different monthly/ yearly amounts depending upon the prevailing long term interest rates, type of annuity and the company's analysis of the policyholder's longetivity (again too many variables to even give a decent approximation). So, even if they look lip-smacking (7-9%) at current rates, they may not be so 10-20 years down the line. Let us analyze this a little further. A 7-9% annuity rate may appear to be good, but if you realise that the amount provided is FIXED for the term of annuity, then that means at an inflation rate of 7-10%, this FIXED amount will start to look small within 5-10 years. And I am not even speaking about 20-30 years down the line. The purchasing power will diminish rapidly later on and this supposedly decent amount will look like a small amount later on.
A Look at Charges:
- 1.Premium Allocation Charges. 2.5%. So out of every 100, 2.5 will be cut and never invested at all. Why? Do not know. Compare this to normal mutual funds – zero. Of course, this charge will continue for 1-10 years, and 11th year onwards, they will give me 102.5% of my premium. Which means they will add an extra 2.5% and invest that amount. Good. But a 2.5% cut in first year does not match with a 2.5% addition in later years. Then some plans are said to be for 10 years only. Even the top up premiums get a 1% deduction. Absolutely horrible.
- 2.Policy Admin Charges. 0.4% per month of Premium. So that means, about 5% (12x0.4=4.8) of the premium will be deducted in administering my policy over and above the normal fund charges.
- 3.Mortality Charges- If the fund value is less than the alternative mortality benefit (premiums @ 6% value), then a corresponding amount of life cover will be given and the appropriate mortality charges will be deducted.
- 4.Investment Guarantee Charge- An additional 0.4% per annum for guarantee. This is the charge for providing a guarantee of 101%. In all, a very bad charge.
Some of the charges are subject to alteration too with prior approval of IRDA.
Service Tax is another charge which is applicable to all charges (it really is a charge by the government, and not really the insurer's fault).
Take Away Points:
- 1.A pension plan is a complicated product with lot of ifs and buts during the buying period. And mostly lot of disappointments for later years.
- 2.Only 1/3 is taxfree in hand at the time of maturity.
- 3.Rest has to be used to buy an annuity. (Alternative is create a corpus other than a pension plan, and then use it to buy the annuity, if you really find the annuity options good at the time of purchase.
- 4.There are a lot of bad charges, which really do not give any decent advantages.
- 5.In this particular plan, since there are no alternative funds, one does not even get the “supposed benefit” of switching from equity to debt. (I must say, even that benefit is really very difficult to make use of. Invariably, you will tend to shift from equity to debt at low levels and vice versa).
- 6.Any guarantee will be charged. Any risk will be charged. Nothing is free. One needs to understand whether that guarantee / risk deferment is really worth the money or not.
- 1.It is probably good for people who do not understand the basics of investing and want an emotional need to be satisfied by having a pension plan in their “portfolio”. And who have so much money, that even if their money is kept as cash, it can serve them easily.
- 2.This plan is still better than the completely opaque non-Ulip retirement plans.
I have specifically taken up the HDFC Life Pension Super Plus plan in this case. But, the basics of analysis will be same all across.
Addendum: Annuity is a plan, usually by insurance companies, in which you pay a single premium and then the company in turn pays monthly/yearly amounts to you for the rest of your life (single life annuity), or your life as well your spouse's life term (joint life annuity). This amount is mostly based on the long term interest rates & life expectancy of you (and your spouse). So if you are already very old, you will get more income, while if the long term interest rates are low, you will get less.
There is an option of increasing amounts (usually 1-3% per year).
There are some other options like cash refund (option to buy back), a fixed term of payments (like 10 years or so), etc.