Pension Funds in India

Retirement planning in India has now been made easy with multiple options available such as the NPS, ULIPs, annuity plans with life cover, etc. Briefly, pension funds work in two stages - the accumulation stage and the vesting stage. The former is when you save for the future and the latter is when you reap the benefits after retirement. These funds are regulated by the Pension Regulatory and Development Authority (PFRDA) of India. 

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What are Pension Funds?

Pension funds are investment avenues for individuals to start saving for their life after retirement. The accumulated amount is offered to you in regular payouts once you retire, creating a source of income to support yourself and your family’s needs. Retired individuals can also choose to receive the whole amount in a lump sum. In such cases, one should carefully plan out the finances to make sure that they don’t run out of funds in the long term.

How do Pension Funds work in India?

Pension funds in India work in two broad stages - wealth accumulation and fund distribution.

  • The first stage is when the investors keep investing a portion of their income in a pension fund of their choice till the time of their retirement.

  • The second stage (also known as the vesting stage) starts after retirement and continues till the death of the investor. During this period, the accumulated wealth is paid out to the retired person in a series of annuities.

It is important to understand that people come from different age groups and with different financial backgrounds and future goals. As such, several retirement planning solutions have been introduced in India to cater to the unique needs of each individual.

Here’s a look at how each type of pension fund works.

  1. NPS (National Pension Scheme)

    Introduced by the Government of India, the NPS allows the working class to reap the benefits of the equity market with affordable investments. The working of the NPS is described below -

    • You are required to open a Tier I account with a minimum deposit of Rs. 500.

    • You can invest a sum at regular intervals throughout your employment.

    • The invested sum can be allocated (per the risk appetite) to equities, corporate debt securities, or government securities.

    • The sum starts accruing interest & returns based on the market performance of the chosen funds.

    • A total of 60% of the accumulated sum can be withdrawn at the age of 60.

    • The remaining 40% has to be reinvested in an annuity plan from an insurer.

  2. Insurance-based Annuity Schemes

    These are traditional pension plans that offer guaranteed returns in the form of annuities or death benefits. The combination of insurance coverage along with pension makes this low-risk investment a favourable choice among the public. The payouts of such plans operate in the following manner -

    • You pay regular premiums for a period against the desired pension and annuity payout.

    • The insurer invests this premium in debt funds and government securities.

    • If it’s a pension fund with immediate annuity, you will start receiving payments as soon as the investment period ends.

    • If it is a deferred annuity plan, you will start earning a regular income at a future date.

    • These plans come with a life cover, so if your die within the coverage period, your family will receive the assured death benefit.

  3. ULIP (Unit-linked Insurance Plan)

    Unit-linked insurance plans are those that offer dual benefits of insurance protection and returns from market-linked investments. Here’s how these pension plans work -

    • ULIP-based pension schemes charge a premium amount against the desired financial coverage.

    • A part of the premium is invested in market-linked funds, which generate returns per market performance.

    • The accumulated fund value is paid to you at the time of maturity or retirement.

    • The insurance component ensures that your family remains financially protected if you were to die within the policy period.

  4. Mutual Funds

    Mutual funds are pure investment instruments that allow investors to put money into different shares of a company. These should be opted for based on your risk profile. Low-risk pension funds include debt funds, corporate bonds, and government securities. High-risk funds are equities, stocks, etc. Such pension funds in India work in the following way -

    • These are solution-oriented mutual funds that specifically target retirement goals of investors.

    • These pension funds invest in a mix of debt and equities.

    • You can either start an SIP or make a one-time investment.

    • The returns vary as per the fund chosen.

    • You can start withdrawing funds once the lock-in period ends or continue investing to increase the returns.

Discontinuing a Pension Fund

For pension plans that come with insurance benefit, discontinuing premium payments can terminate the policy. It is advisable that you check the surrender benefit of the plan and the paid-up policy to avoid losing all your money. You can also revive a policy by paying the requisite premium amount. In the case of ULIPs, you will receive the fund value accumulated till the time of discontinuation. With solution-oriented retirement funds, you can simply stop your ongoing SIP payment and redeem the fund value after the lock-in period. If you do not redeem it, the discontinued fund shall continue to accrue returns.

Summing Up!

Now that you are aware of how pension funds work in India, you should start planning your retirement immediately. Inflation in the country is at an all-time high. Your savings alone won’t be sufficient to support your family’s needs once you have retired with no income. Therefore, retirement planning with pension funds is the way forward for a financially secure life. However, with the range of options available, it is important that you do your due diligence before investing your money.

*All savings are provided by the insurer as per the IRDAI approved insurance plan.
*Tax benefit is subject to changes in tax laws. Standard T&C Apply
^The tax benefits under Section 80C allow a deduction of up to ₹1.5 lakhs from the taxable income per year and 10(10D) tax benefits are for investments made up to ₹2.5 Lakhs/ year for policies bought after 1 Feb 2021. Tax benefits and savings are subject to changes in tax laws.
+Returns Since Inception of LIC Growth Fund
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^^The information relating to mutual funds presented in this article is for educational purpose only and is not meant for sale. Investment is subject to market risks and the risk is borne by the investor. Please consult your financial advisor before planning your investments.

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