Can you fund your own pension? Yes. You can actually fund your own retirement pension.
Many salaried employees think that this is only possible for Govt or PSU employees. They aren’t sure how they would meet their retirement needs.
Well you have a few choices to build your egg nest which will provide for your monthly income in sunset years.
Option 1 – SIP & SWP through Mutual Funds
SIP – Here one can contribute a predetermined amount each month over a period of time.
SWP – This starts when one retires. One withdraws a pre-determined amount monthly / quarterly or at regular intervals to cover for expenses in retirement.
Let’s take an example of Mr. A who is 35 years old with monthly expense of Rs.35000/-. He will retire at age of 60 years.
Assuming inflation of 7% each year, his monthly expense of Rs.35000/- today will increase to Rs.1.9 lacs (35000*1.07^25) at retirement.
He plans to start a monthly SIP to support his retirement needs & shall continue to invest each month for next 25 years. This monthly SIP is effectively creating a cycle for monthly withdrawal in his sunset years.
Assuming his monthly investment will generate 12% annualised return over 25 years, all he needs to invest each month is 12000/- in first year. The investment amount must be increased by 7% each year to factor for inflation. i.e 12840/- each month in year 2, an additional 7% over 12840 in year 3 & stepping up each year.
This should continue over 25 years. when he retires he is ready to do his first SWP – “Systematic Withdrawal Plan”.
Since the money has been invested over 25 years there is zero tax liability (any equity MF investment over 1 year has zero tax liability). Since the corpus continues to stay invested in MF during retirement it continues to earn superior tax free returns.
Compare this to a MF Dividend Plan which is not a great idea as though the dividend is tax free in your hands, the MF House has to pay Dividend Distribution Tax of 30%+. This money obviously goes from your investment effectively reducing your corpus.
Option 2 – NPS – National Pension System which is over seen by Govt appointed PFRDA (Pension Fund Regulatory & Development Authority)
Here an Indian National between the age 18-60 can contribute a minimum of Rs.6000/- each year or more until age of 60. On retirement he has the option to buy a Pension Plan with the entire corpus or buy a Pension Plan with 40% of the corpus & withdraw the remaining amount.
During the accumualtion phase one can choose the investment options for his / her corpus. This can either be E – Equity MF (max 50%), C- Corporate Bonds or G – Govt Securities. One can also choose the automatic allocation option where the money is invested in pre-determined ratios linked to your age.
The disadvantages of NPS are:
- You can’t withdraw any money until 60 years
- On retirement one can with draw 60% of which 40% is tax free. 20% is taxable at marginal rates
- 40% of balance on retirement has to be invested in an annuity i.e. purchase a pension plan. Returns from Pension Plans are pretty low & aren’t tax free. Effectively reducing one’s returns.
For people who aren’t financially savvy, this is a good option. Also, the charges on NPS are very ver low & hence it bumps up your returns by that margin.
Option 3 – Rent from Properties
Many believe buying properties for rent is a good option for retirement. Not really since returns are a pittiance 2-2.5%. The rent is taxable & flat maintenance takes away some of your rent.
eg. someone owning a flat costing 1 Cr. today can expect annual rent of Rs.2.4 lacs (2.4%). Maintennace would be in range of Rs.30000-36000/- & tax liability would be about Rs. 24000/-. Effectively one only makes 1.8 Lacs which is very low. Compare this with a MF which at 10% will generate Rs.10 Lacs tax free. In sunset years you shouldn’t be much worried of property appreciation unless you want to leave an inheritance for your children.
I would always recommend a “SIP-SWP” for Retirement Planning – your own Pension Plan!!