Pension... Wow! The word was truly a music to Vermaji's ears.
A lifetime of vacation with no bosses, no deadlines, no stress; but with the income flowing in every month... uninterrupted... forever.
Tragically, however, the plans promising a lifetime of pension turned out to be an absolute disappointment.
Why:
Firstly, they are NOT a pension, in the truest sense of the word.
Ideally, pension should be a remuneration that your employer (or Govt. or some entity) pays you after you retire, without any contribution from you.
This is what the Govt. employees, who retired prior to 2004, receive every month.
... They did not contribute anything.
... They receive their pension based on the post they held at the time of retirement.
... Further, based on inflation, their pension amount increases year after year.
... Moreover, Pay Commissions often revise the scales; further adding to their monthly kitty.
Whereas, pension plans as available in the market and which Vermaji bought, are nothing but distribution of returns from an "accumulated corpus". This "accumulated corpus" was nothing but the sum amassed during Vermaji's working period out of "his own savings".
In other words, while Vermaji was in the working phase of his life, he contributed a defined amount every month to a fund. After he retired, the income generated from this fund is returned to him as "pension" every month.
Effectively, it is the return on "his investment" that is given to him in the form of "pension".
It is exactly like say your Bank Fixed Deposit or any such investment, which pays you interest every month. Here, it is just given the name of "pension".
Moreover, as the accumulated fund corpus is fixed, Vermaji will receive the same fixed amount forever. There is NO PROTECTION against inflation..
Therefore, in typical pension plans, the word 'pension' is a misnomer and misleading.
So, if this is not a pension, but an investment, the question we need to ask is...
... Is it a "good" investment?
The answer is an... emphatic NO.
First problem of course is the (poor) returns:
Vermaji realises that even the most simple product like bank fixed deposit would have paid him more interest than the pension that he earns.
If he had the choice, he could have invested the same corpus smartly and intelligently. Thus he could easily make lot more money than the monthly pension.
Therefore, from returns point of view, it simply makes no sense to invest in a pension plan.
Second problem is the (inefficient) taxation:
Pension is fully taxable. Whereas, if Vermaji had a choice, he would have opted for more tax efficient investments.
Since he falls in the 20% income tax bracket, he could have easily reduced his tax liability by investing in tax-free bonds or debt mutual funds vis-a-vis the pension annuity plan.
Third problem is the (complete) lock-in:
Vermaji has no access to his investment in the pension plans. Based on the annuity option he has chosen, his children will receive the corpus after his death.
As such, last year when Vermaji needed a large sum for his wife's operation, he was totally helpless. Pension plan gave him NOTHING, not even a rupee extra other than his monthly pension.
Nowadays, the retirement period is at least 20 to 30 years long. Therefore, this loss of access to one's capital is a serious drawback.
Fourth problem is the (nil) flexibility:
Vermaji could neither choose the type of fund in his pension annuity, nor can he change it from time to time.
Instead, if he had the choice, he would have distributed his corpus across equity, debt, gold and real estate. And, depending on the market conditions, he could change the allocation from time to time, so as to maximize his returns. Pension Annuity offers no such flexibility to Vermaji.
Fifth problem is the (zero) growth:
In his pension plan, Vermaji will receive a "constant" amount throughout the next 20 to 30 years. This, as you will appreciate, is a disaster. Inflation will make things expensive year after year. Thus, the fixed pension will suffice, for only the first few years. Thereafter, the amount would be ridiculously small and useless for Vermaji's daily needs.
Instead, if he had the choice, he would have invested the same money in say a property. This would have given him "increasing" rental income every year and thus protect him from the risk of inflation.
In view of the above-mentioned 'really grave' drawbacks, I always advise people to make their "own" retirement plans, rather than depending on the "so-called" pensions plans available in the market.
A lifetime of vacation with no bosses, no deadlines, no stress; but with the income flowing in every month... uninterrupted... forever.
Tragically, however, the plans promising a lifetime of pension turned out to be an absolute disappointment.
Why:
Firstly, they are NOT a pension, in the truest sense of the word.
Ideally, pension should be a remuneration that your employer (or Govt. or some entity) pays you after you retire, without any contribution from you.
This is what the Govt. employees, who retired prior to 2004, receive every month.
... They did not contribute anything.
... They receive their pension based on the post they held at the time of retirement.
... Further, based on inflation, their pension amount increases year after year.
... Moreover, Pay Commissions often revise the scales; further adding to their monthly kitty.
Whereas, pension plans as available in the market and which Vermaji bought, are nothing but distribution of returns from an "accumulated corpus". This "accumulated corpus" was nothing but the sum amassed during Vermaji's working period out of "his own savings".
In other words, while Vermaji was in the working phase of his life, he contributed a defined amount every month to a fund. After he retired, the income generated from this fund is returned to him as "pension" every month.
Effectively, it is the return on "his investment" that is given to him in the form of "pension".
It is exactly like say your Bank Fixed Deposit or any such investment, which pays you interest every month. Here, it is just given the name of "pension".
Moreover, as the accumulated fund corpus is fixed, Vermaji will receive the same fixed amount forever. There is NO PROTECTION against inflation..
Therefore, in typical pension plans, the word 'pension' is a misnomer and misleading.
 |
| Pension plans are, in reality, investment plans with really serious problems. |
So, if this is not a pension, but an investment, the question we need to ask is...
... Is it a "good" investment?
The answer is an... emphatic NO.
First problem of course is the (poor) returns:
Vermaji realises that even the most simple product like bank fixed deposit would have paid him more interest than the pension that he earns.
If he had the choice, he could have invested the same corpus smartly and intelligently. Thus he could easily make lot more money than the monthly pension.
Therefore, from returns point of view, it simply makes no sense to invest in a pension plan.
Second problem is the (inefficient) taxation:
Pension is fully taxable. Whereas, if Vermaji had a choice, he would have opted for more tax efficient investments.
Since he falls in the 20% income tax bracket, he could have easily reduced his tax liability by investing in tax-free bonds or debt mutual funds vis-a-vis the pension annuity plan.
Third problem is the (complete) lock-in:
Vermaji has no access to his investment in the pension plans. Based on the annuity option he has chosen, his children will receive the corpus after his death.
As such, last year when Vermaji needed a large sum for his wife's operation, he was totally helpless. Pension plan gave him NOTHING, not even a rupee extra other than his monthly pension.
Nowadays, the retirement period is at least 20 to 30 years long. Therefore, this loss of access to one's capital is a serious drawback.
Fourth problem is the (nil) flexibility:
Vermaji could neither choose the type of fund in his pension annuity, nor can he change it from time to time.
Instead, if he had the choice, he would have distributed his corpus across equity, debt, gold and real estate. And, depending on the market conditions, he could change the allocation from time to time, so as to maximize his returns. Pension Annuity offers no such flexibility to Vermaji.
Fifth problem is the (zero) growth:
In his pension plan, Vermaji will receive a "constant" amount throughout the next 20 to 30 years. This, as you will appreciate, is a disaster. Inflation will make things expensive year after year. Thus, the fixed pension will suffice, for only the first few years. Thereafter, the amount would be ridiculously small and useless for Vermaji's daily needs.
Instead, if he had the choice, he would have invested the same money in say a property. This would have given him "increasing" rental income every year and thus protect him from the risk of inflation.
In view of the above-mentioned 'really grave' drawbacks, I always advise people to make their "own" retirement plans, rather than depending on the "so-called" pensions plans available in the market.
