How to avoid a retirement insurance loss

What does the term Retirement Insurance imply

Retirement Insurance is an assurance that a person leads a comfortable life and continues to earn a decent income every month even after he stops working.
So, the first thing in everyone's mind on reading the title of this article would be "Can insurance be subject to losses? Is it not a fool-proof area? The answer is "Yes, insurance is very fool-proof till the choice is made wisely and after research of various options available in the market."
Nowadays most of the pension plans are equity market related and any product which is related to the market is filled with risks. Every year, during March end, we see a line of insurance agents at our office trying to sell the products which have a tax deduction under Section 80C and pension plans are one among them. Investors fall prey to the lucrative returns promised by these agents and they invest their hard earned money without doing much research or reading the terms and conditions properly. Mostly this is due to lack of time during year end when everyone needs to submit tax saving details to the finance department. Such investments done in haste and without working out the maturity benefits properly lead to heavy losses.
Retirement insurance, if not properly planned and executed can lead to heavy losses which can be very difficult to make up at a later stage of life.

Why Retirement Insurance

Inflation factor

The amount earned during the retirement phase should be sufficient enough to meet all expenses during that period. However, it is very difficult to determine the exact amount that would be required at that time as the inflation factor is not at all predictable. The inflation has been a major concern during the current times with the prices of all products spiralling. The prices of all products have more than doubled during the past five years.

Rise in nuclear families

The joint family system is now giving way to nuclear families in almost 80% of places. The increasing feeling of need for independence and lack of enough support during the old age days have made people realise that they need to be ready with the amount required for their needs in old age.

Longer retirement phase

Earlier the percentage of people working in Government jobs was more than private jobs in the ratio of 85:15. The Government employees were assured of pension, had job security till the age of 60 and had no need to save for their old age.
However, now the proportion of Government jobs to private sector jobs had drastically reduced to ratio of 4:96. The private sector does not assure job service till age of 60 and also does not provide pension. Moreover, private sector prefers to employ young professionals with updated knowledge of latest technology than seniors already working in their organisation. Most private sector employees retirement age is thus, reduced nowadays to almost 45-50 years. They start their own business or consultancy after this age but the earning power is still not the same as during the earning years. Since the non-earning phase is longer, the need for retirement insurance has become a necessity.

When to start retirement planning

The mantra for retirement planning is “Start early and keep investing to take advantage of compounding effect of money.”

How much for Retirement Insurance

Thumb rule is 80% of current income factored by projected inflation index.
The amount to be saved regularly for retirement insurance is also based on various factors such as:
• Stage of life when the retirement insurance fund is entered into;
• Expected retirement expenses keeping inflation in mind;
• Expected retirement income from existing sources like gratuity, superannuation etc;
• Existing asset allocation.

Where to invest

Options for retirement insurance include various financial instruments:

Pension plans

Pension plans have become the need of the hour in today’s age just like life insurance and health insurance.

Overview of Pension plans

Pension plans are the safest remedy for securing the old age. These are plans offered by the insurance companies with a combined benefit of insurance and investment. A pension plan has two phases:

Accumulation phase

In this phase investor pays the premiums regularly till a specified age/ number of years as per the terms of his policy.
The insurance company invests the funds received from the insured in specific investments determined by Insurance Regulatory Authority of India.

Annuity phase

This is the phase when the insurance company starts paying pension to the insured as per his vesting age. “Vesting age” is the age at which the insurer starts receiving pension. The vesting age can be anywhere between 40 years to 70 years as determined by the insured at the time of taking up the policy. 33% of the amount can be received as a lump-sum and the rest paid as pension either monthly/quarterly/annually.
There is also an option of immediate annuity wherein the insured pays a lump-sum to an insurance company and they start the pay out immediately. This option enables an insured to take up a pension plan with a company and if not satisfied, receive the entire surrender amount and use the facility of immediate annuity from another company.

Types of pension plans

Pension plans come in two variants

Traditional plans

The amount of pay-out in such plans is guaranteed. The premiums received in this plan are invested in Government securities, debt funds and other Government schemes by the insurer. The funds are safe, secure and stable. The returns vary between 6-8%.

Unit Linked Insurance Plans (ULIP)

The amount of pay-out in such plans is invested in financial instruments equities and equity related instruments which are expected to appreciate over time. There is definitely a market risk associated in these instruments. The returns may be somewhere between 8-12% depending on market conditions. The reason for investment in these schemes is based on the rule of “More risks, more returns.”
There is an option for investors to choose the proportion of allocation between equity and debt. There is also an option of "Lifecycle stage fund" wherein proportion of funds in equity is higher in the younger days and as age progresses, investment in debt instruments are higher than equity. This, in my opinion, is the best option for an investor investing in ULIP as the fund manager uses his best discretion in allocating between funds and the investor gains from professional management.
The criteria to decide between traditional plans and ULIPs for an investor are to be based on the time of entry into the plan. If the amount invested is for a very long period, then ULIP is the best otherwise it is prudent to go with traditional plans.

Public Provident Fund (PPF)

PPF provides returns directly based on returns from Government securities. The current rate of interest is 8.8% per annum and the returns are totally tax free. Minimum investment in this fund is Rs.500/- every year and maximum investment is Rs.1,00,000 every year. The lock in period is 15 years though loans can be availed after specific number of years. Safety and tax free returns are the major feature of this product. This is also the favourite investment destination for most Indians.

Mutual Funds

The new mantra for long term savings is SIP (Systematic Investment Plan) in various mutual funds. The returns from this regular monthly savings are based on market movements but over a long period of time, it is expected to generate great returns. Some institutions have come out with the feature of Target Investment Plan (TIP) wherein the investor determines the target return expected after specific number of years. The fund manager allocates the funds in various mutual funds based on the monthly SIP that can be invested and the target amount determined by the investor.

National Pension Scheme

This scheme is aimed at providing pension based on market returns during old age to the investors thus assuring a secure life. This scheme has been floated by the Pension Fund Regulatory Development Authority of India. NPS offers six fund managers and three investment options to choose from. Investors can choose the fund manager and the fund option depending on their asset allocation. In case no option is exercised by the investor, “auto choice” option will be implemented wherein the ratio between equity and debt funds is pre-determined.

Employees Provident Fund

This is the most common option for salaried employees. An amount equal to 12% of the salary (Basic+DA) is deducted from the salary and an equal amount contributed by the employer. Employees also have the option to increase their own contribution to EPF scheme. The fund saved by EPF along with interest is given back to the employee during retirement. This is one of the best risk free instruments and risk adjusted returns are also very good.

How to avoid losses from retirement insurance portfolio

Diversification is the only remedy to avoid losses. A single investment option should not be totally relied upon.
Minimum loss in one scheme should be offset from gains in another scheme. Nowadays, pension schemes come with an option for investors to choose between different funds and switch over between various funds during the tenure of the scheme. The life-stage cycle plan wherein the premiums are invested based on the age of the investor is the most beneficial of all schemes. A young person is considered to take more risk and hence amount of funds in equity is higher during the young age. As age progresses and person reaches his middle age with commitments, there is shift from more equity to more debt funds and so on. An in-depth study of each scheme should be done before investing in any particular option as the security in old age depends on sound decisions made during the earning age.
Retirement planning through investments in right mix of financial instruments will definitely maximise returns and assure a secure and tension free life. The returns from financial instruments combined with a property to live and health insurance will add to the happiness of your old age.