Four Popular Retirement Planning Options - Compared

Where do you save for your retirement? Simply stacking away money won’t help; since your retirement is likely to be a long-term goal, your choice of instrument can have a massive impact on the size of your final corpus. The effect of compounding gets amplified over the years, and even a 2-3% difference in returns can make a difference of lakhs or crores on your final nest egg. Let’s compare the pros and cons of a few popular retirement planning tools.

Life Insurance

In India, Life Insurance is probably the most preferred vehicle for creating a retirement corpus. However, since the bulk of Life Insurance savings take place in low-yielding traditional plans, the practice of diverting long term retirement funds to Life Insurance is highly questionable, to say the least. Very few Indians really use Life Insurance for its actual purpose (risk transfer), preferring to use it as a savings tool instead. Post their rehabilitation, some low cost ULIP’s could prove to be much better than traditional plans from a retirement planning standpoint.

Pros: tax efficiency, growth prospects (for ULIP’s only)

Cons: very low returns (traditional plans), illiquidity, opacity of benefits

Public Provident Fund

The trusty PPF remains the preferred retirement savings tool for most Indians. Whereas the tax-free returns and safety of principal tend to turn investors in its favour, it’s worth noting that an 8% post tax return over a long period of say, 20-30 years is really a compromise. Investors should be gunning for a bare minimum double-digit post-tax return from their long-term retirement savings. The lock-in period of 15 years (partial withdrawals allowed after 6) actually work in its favour.

Pros: safety of returns, tax efficiency

Cons: low returns, considering the long-term nature of a retirement planning goal

NPS

In 2009, the government opened up the NPS structure (National Pension Scheme) and extended it to all citizens. NPS investors can start with a minimum of Rs. 1,000 per year and divide their investments between three fund categories, namely E (Equity), C (Corporate Bonds) and G (Government Bonds). Alternatively, they can opt for one of three Life Cycle funds that automatically balances their asset allocation between these three funds as per fixed formulae. At maturity, NPS investors mandatorily need to purchase an annuity with 40% of the corpus from one of seven ASP’s (Annuity Service Providers). Investors can also choose from eight pension fund managers. 

Pros: tax efficiency, better return prospects compared to fixed income, strict lock-in for Tier 1 accounts that enforces discipline

Cons: mandated purchase of low return annuity, underperformance of equity funds vis a vis mutual funds

Fixed Deposits & Savings Accounts

Despite widespread efforts to create awareness about the perils of diverting long term savings to low return assets, a staggeringly large cross section of Indian retirement savers invests in fixed deposits and savings accounts to create their retirement funds. Not only are these instruments tax-inefficient; they also provide returns that fail to outpace inflation. Over the long run, such excessive conservativeness can cost retirement savers dearly.

Pros: Principal Safety

Cons: Very poor returns, inflation risk, tax inefficiency

Mutual Funds

Over the past five years, we’ve witnessed a steady increase in awareness levels about mutual fund investing within the middle-income group. SIP’s (Systematic Investment Plans) indeed represent a formidable option when it comes to saving from your retirement. Run by professional fund managers, mutual funds tend to outperform other asset classes over long timeframes. By starting SIP’s in an aggressive portfolio of mutual funds, increasing them in a disciplined manner every year, and continuing them throughout market cycles, one stands a good chance of creating a sizeable retirement corpus. For best results, retirement savers are advised to keep their equity allocations high (>80%) until the five years immediately preceding their retirement.

Pros: Scope for high returns, tax efficiency, flexibility, professional management

Cons: Equity Funds can be high risk, liquidity works to the disadvantage of mercurial investors as they tend to keep stopping and starting investments to their long-term detriment. Also, they are susceptible to behavioural pitfalls and very few investors actually end up earning published returns over the long run!