pension plans

Pension Plans: Wolf in sheep’s clothing?

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I started investing in HDFC Pension Champion from Year 2010 for sum of Rs 1,50,000 per annum. I have completed 5 years of investment and I see the returns as of today is @ 8.02%. I stopped investing from this financial year, as the returns are less than the normal FD rates. I am thinking to invest in Mutual funds instead of ULIP.

I understand from your previous articles that, if I wish to surrender the policy no taxes to be paid and no reversals of 80C deductions as the invested period was 5 years.

The above note is what a reader (I will call him Rajesh) sent to me recently.

I believe that you or someone you know also owns a pension plan. We have a few lessons to learn here. First, some basics.

What are pension plans and how do they work? – The Sheep’s clothing

Pension Plans are a variant of the Unit Linked Insurance Plan or ULIP.  They ride on the idea of earning a pension post retirement, the life stage when there will be no other active sources of income.

You pay premium in a pension plan, typically, on a regular basis. The premium, after deduction of charges, gets invested into various options such as equity, debt or a mix of both.

Like ULIPs, a pension plan also gives you several choices of where you want your money to be invested. There are about 6 to 8 fund options – from an aggressive equity fund which invest upto 80% or more in stocks) to a conservative one which invests 100% the money in government bonds.

The choice of the fund dictates the kind of returns that can be generated potentially from the investment.

When the policy matures, you can take 1/3rd of the maturity value of the funds in the policy immediately and that is completely tax-free. The other 2/3rd money has to be compulsorily converted into an annuity.

The annuity comes to you in the form of regular monthly payments, which you can use to pay off your living expenses. The annuity is like a reverse EMI. Every annuity has a component of the principal + interest in it. However, unlike an EMI, the annuity gets paid to you.

Why do you invest in Pension Plans?

There are 2 big reasons.

#1 The premium you pay helps you get tax savings under section 80C of the Income Tax Act. You see, tax savings continues to be the biggest driver of our investment decisions. Further, words like safety and security are used indiscriminately to get your buy-in for the product.

#2 The promise of guaranteed returns. No one understands what and how much is the guarantee but that’s another debate. The fact that you would receive regular income post retirement is also an added reason. Though you never bother to ask, how much would that income be or what rate of interest would that earn you?

What’s wrong with them? – The Wolf

Let’s begin with the most important one – COSTS.

Like all ULIPs, there are a variety of costs associated with them – Premium Allocation charge, Policy Administration charge, Fund management charge, Switching charge, discontinuation charge, service tax and miscellaneous charges.

Let’s take an example. I looked up LIC Pension Plus. This is how it describes its charges for Regular premium policies.

  • Premium Allocation Charge (% of premium paid)
    • First Year – 6.75%
    • 2nd to 5th Year – 4.50%
    • Thereafter – 2.50%
  • Policy Administration Charge – Rs. 30 per month increasing at 3% per year
  • Fund Management Charge – This is the charge for the investment activity of the fund. For debt funds, it would be in the range of 0.70% to 1.20%; For funds that invest both in equity and debt, it would be in the range of 0.80% to 1.30%.
  • Switching Charge – This is the charge levied on switching of monies from one fund to another. Within a given policy year 2 switches will be allowed free of charge. Subsequent switches in that year shall be subject to a switching charge of Rs. 100 per switch.

After costs comes the ugly truth of Guaranteed Returns

You have to understand one thing first that the investment returns from a pension plan are going to be poor. What I mean is that the returns are going to be insufficient for you to beat the inflation and create a large enough corpus for your retirement. At least that is what the past experience has been.

So, to tap into the fear psyche of the individual, the words like guaranteed are used. In several cases, the way guaranteed returns are presented is like some alien code. So a guaranteed return would be something like 3% of Sum Assured of the policy.

One needs to question, what is the linkage between Sum Assured and returns. Returns are and should be calculated in the terms of the premium paid, that is the actual investment.

Confusion is the hallmark of the marketing of such plans. Here’s a classic from the marketing material of the pension plan Rajesh bought. The Premium Allocation Rates are guaranteed for the entire duration of the policy term. Can you really beat this?  The costs are guaranteed? Wow!

The same LIC pension plus plan mentioned above does a little better by explaining it in the right terms. It guarantees a maximum of 6% per annum and a minimum of 3% per annum interest on the premiums paid.

The question that you still need to ask is – Is this even enough to cover for the rising prices, inflation?

Let’s now talk about the Surrender Rules for pension plans.

Now, unfortunately, the surrender rules for other insurance plans do not work for pension plans. If Rajesh surrenders the pension plan before maturity, his entire surrender value will be added to his income and taxed as per current tax slab. Also, as stated before, 2/3rd of the surrender value will have to be converted into annuity. That is compulsory.

Rajesh will also have to return all the tax benefits under 80C benefits earned in the past years.

Then comes the trust factor.

You tend to trust the person who recommends the pension plan to you. Rajesh did that too. He trusted the advice of the relationship manager at his bank who was acting out of pure self-interest with no consideration for Rajesh.

The whole thing is crying only one word – WOLF, WOLF, WOLF!

So, what should Rajesh do with his Pension Plan?

The options with Rajesh to deal with the Pension Plan are:

Option 1: Stop paying any further premiums and let the policy continue with the current fund value. He should ensure that the funds are invested in the Equity Managed Fund II, the option with the maximum equity exposure.

Option 2: Reduce the term of the policy and the premium amount to as low as possible. When finally the policy matures, he can get 1/3rd of the maturity in lump sum (tax free) and 2/3rd will have to be converted into an annuity (regular payments).

Surrender of the pension plan policy was not an efficient option for him. 

Please note that these options are specific to Rajesh’s situation. The choices could vary based on various factors in your situation. Hence, do not consider this universal advice.

Between you and me: So, what’s your view on Pension Plans? Do you have an experience to share? Then head over to the comments now.

26 thoughts on “Pension Plans: Wolf in sheep’s clothing?”

  1. Hi,

    I am completing 10 years of my ICICI Pru lifetime super pension plan. I have paid 3 installments yearly. Now, those marketing guys (wolves) from ICICI PRU tells me that if I transfer all my fund in a 5 year insurance plan (i do not know which one), then I do not have to pay any tax even on 2/3 of the maturity value. Please clarify, if that is true.

  2. HDFC Pension Super Plan is only the name of the Scheme. It has nothing to do with ‘defined pension schemes’.
    Only when you purchase annuity from a recognised AMC, then 1/3 is tax free. Any person received from any source including from any ‘pension fund’ is taxable.
    This is my understanding.

  3. Dear Vipin,

    I had invested in HDFC Pension Super Plan in 2010 and paid 3 annual premiums (50000 each) amounting to 150000. I discontinued paying further till 2015 and surrendered my policy after completion of 5 years. I received a lump sum surrender value of 208152.39 and no TDS was deducted.

    Am I liable to pay tax considering the total amount of 208152.39 by adding it to my annual income OR
    Do I have to pay tax only on 2/3rd amount, i.e. 138768.26 by adding it to my annual income OR

    Do I only have to pay tax on the interest earned, i.e. (208152.39-150000) = 58152.39 by adding it to my annual income

    Please let me know at the earliest as tomorrow is the last date for tax return filing.

    Thanks in advance

  4. dear Mr Vipin
    I have purchased Pension Elite plan from Aviva Life Insurance as per details hereunder :
    Commencement date : 21-11-09
    Annual premium : 1 lac
    Policy Term : 20 years
    Maturity date : 21.11.2029
    Sum Assured : 25,000.00 (Twenty five thousand only)
    Prem payment term : 20 years

    So far i have paid 7 premiums on annual basis and the present fund value is 9,05,000.00
    No surrender charges after 5 premium years.

    if i do not wish to continue paying more premiums as the premium payment term is too high ie till 2029 and want to surrender the policy now , what would be the tax liability for me . The company will release the fund value after deducting the TDS @2%.
    I have taken the benefit of section 80 c on the premiums paid , while computing my income tax return in the previous years.

    Hope i have provided you the complete information enabling you to give me a suitable advise

    • Dear Amit, in my understanding 1/3rd amount is tax free. 2/3rd amount is taxable as per your tax bracket, if you withdraw it lumpsum. You can convert it into annuity and defer your tax. No reversal of past tax benefits needs to be done. Hope this helps. Thanks

      • Thanks Mr Vipin .
        I spoke to the company and was told that the option of annuity is available only on maturity . If I surrender the policy prior maturity , they would pay me the fund value after deducting the TDS @2%.

        So , what other option is left with me ? Will the full Surrender value be taxed as per applicable tax or only the income/profit part eg I have paid 7 premiums @1lac per year amounting to total Rs 7 lac and the present fund value is 9 lac. I need to pay tax on 9 lac or 2 lac ( income part). Please advise

  5. Hello Vipin,
    I was searching for help or guidelines online on tax implications on surrendering pensions plan. I came across this article which I found to be very good article and thought of writing to you for my case get your advise on this. I have 3 ICICI pru policies , details given below (Policy Name, Policy Start Year, Policy Maturity Year, Sum Assured, Premium Paid Value, Current Fund Value, Current Status) :
    1. Life Time Super Pension, 2007, 2027, 200000/-, 136250/-, 234678/-, Monthy SIP in progress for 2000/- i.e. yearly 24000/-

    2. Life Stage RP, 2008, 2018, 75000/-, 45000/-, 67200/-, Stopped paying yearly premium (Rs. 15000/-) after 3 yrs locking period.

    3. Life Stage Pension, 2009, 2028, Zero Sum Assured, 170000/-, 236742/-, Monthy SIP in progress for 1250/- i.e. yearly 15000/-

    I would like to know the tax implications when I surrender these policies, specially the pension one’s. I come under 30% taxslab, and I have declared these as investment under 80C since last 5+ years i.e those are showing on my Form 16, however there were other components too like Home Loan Principal, PPF and LIC etc where sufficient to complete 80c exemptions.

    I really don’t want to increse my tax out go while filing tax returns, and looking for options to save some tax here. When I took all above policies the tax implications weren’t there. Should I continue paying for 2 pension plans mentioned? What are the tax implications if I surrender these policies? and Do I have to pay tax on entire Fund Value or only Gained value post surrender?

    I hope I have tried my best to narrate my problem here. Plesae provide your valuable guidence/advise to help me out. Let me know if you need more information. Thanks in advance

    • Dear Nils

      Thanks for the detailed info. Here are some points for your consideration.

      Firstly, the policy 2 is the simple one here. It is a ULIP and if you surrender it, there is not tax payable at all.

      Now, I am not sure of your calculation of premium paid till now. In Policy 1, if you are paying Rs. 2000 a month, it is 24000 a year and hence for 10 years you have paid Rs. 2.4 lacs.

      Similarly, in Policy 3, Rs. 15,000 a year for 8 years is roughly Rs. 1.2 lacs.
      You have mentioned Rs. 1.36 lacs in policy 1 and Rs. 1.7 lacs in policy 3. Please check that.

      I have worked with the actual premium amounts and not those mentioned by you.

      Now your current returns from the policy are nothing to write home about – less than half a % over the years they have been subscribed to. Not sure which fund type you have chosen in these policies. In fact, in the first policy, you are making a net loss with the current policy fund value less than the amount of premium you have paid.

      In my view, you can surrender your pension policies and find other avenues for your investment. As for the tax on pension plans, there is a different treatment. You can take 1/3rd of the total value as tax free withdrawal but the remaining 2/3rd has to be either converted into an annuity (which is counted as part of your taxable income) or you can have it all at once by paying tax as per your tax bracket. Frankly, you are better off paying the tax and taking the money.

      As for the past deductions under section 80C is concerned, it would be a matter of interpretation here. If you have sufficient alternative proofs for your 80c for past years, just keep them in one place, in case the taxman comes calling to check.

      Hope this information helps you to make a decision.
      Thanks

      • Thanks Vipin for quick response on my query, regarding the calculations for the premium paid till now, I have made mistake swapping Policy 1 and 3 for the current status. Actully Policy 1 I am paying yearly 15K and and for Policy 3 paying 24K annually. Policy 1 and 3 got issued on July 2007 and July 2009 respectively. So Premium actual paid years (till Jun 2016) are 9 yrs and 7 yrs and paid amount i.e. Policy 1 = 9*15K= 135000 and Policy 3 = 7*24K =168000 and on top of this there is some loyalty bonus. Thanks for corrections. 🙂

        I like the idea for surrendering these policies, however not sure about the taxations i.e. Will the total surrender value will be added to my income ? or only gain will be added to income, given I have other alternatives available for 80C benefit for the past years though I have showed these policies under 80C on my FORM16.

        I have also reached out to couple of company advisors, I got following options :

        1. First of all Stop paying monthy ECS on Policy 1 and Policy 2.
        2. Surrender Policy 2 as it doesn’t have any tax implications
        3. Invest Policy 2 Amount in New nonPension Policy and from 2nd year onward continue paying premium from either Policy 1 or 3 Fund Value.
        4. Also other option was to get new non pension policy which can be linked to either policy 1 or 3 and will be surrender later to showcase it as been non pension policy.

        Please confirm on tax implications if I surrender those and thoughts around advise I have received. I am really looking for some way out not to pay tax on these or pay very less tax :).. Thanks.

        • Hi Nils

          Policy 2 can definitely be surrendered without any charges/taxes.
          As for pension policy, I mentioned to you You can take 1/3rd of the total value as tax free withdrawal but the remaining 2/3rd has to be either converted into an annuity (which is counted as part of your taxable income) or you can have it all at once by paying tax as per your tax bracket. Frankly, you are better off paying the tax and taking the money.

          As for the past deductions under section 80C is concerned, it would be a matter of interpretation here. If you have sufficient alternative proofs for your 80c for past years, just keep them in one place, in case the taxman comes calling to check.

          I do not understand the options as suggested by company advisors. Seems like you would be moving from the devil to the deep sea.

          Hope this helps.

  6. Nice article!

    Since you have touched the pension topic here, my understanding is, I can allocate few MFs for retirement but I am not sure how one should follow this to achieve it? like exactly when to withdraw money from MFs which are dedicated towards retirement goals. Any goal basis material/post from you would be highly appreciable,

    • Thanks Umesh.

      IF you invest in MFs, its like a normal portfolio management.

      You have to tag that part of your investment with the goal that you have in mind, for example, retirement. You have to invest and review the progress against the goals. In the review, you kick out any MFs that are not worthy, add others, if required and continue with the rest.

      I note your request.

  7. I have the following observations:
    1. First thing is that any ULIP based plan-whether it uses a word “pension” or for that matter “child education plan” etc. is only a nomenclature used by the AMC companies. However, in case of “pension” plan, since 1/3rd is commuted at the end of the tenure, therefore, it can be classified as “pension” plan.
    2. I have done my calculation and it shows that even if I forego the 80-C tax benefit while making investment in “pension” plan, and invest the same amount every month/year in a “Balanced Fund” (leave aside a pure diversified equity fund) of any good AMC (including that of HDFC – the example taken by you), you will have much more fund at your disposal at the end of tenure than otherwise.
    3. Any withdrawal/redemption from a MF is tax free after one year of investment and therefore no need to pay tax on the “annuity/pension” part of the money received by you after your retirement age.
    4. You can withdraw from your MF scheme at any time without any deduction (except where an exit load is applicable for withdrawal within 1 year or in case a few select schemes within 2 years of investment).
    5. What is so great in guaranteeing a 3% minimum return when you are charging 6.75% in the first year, 4.50% in 2nd to 5th year and 2.50% thereafter till the policy continues.
    The fact of the matter is that net-net you are getting nil to negative guaranteed return.
    6. One should never go for any such plan offered by any Fund House.
    7. My mantra is very simple. Invest in select Schemes of good Mutual Funds and enjoy your life with tax-free return.
    8. MF industry in India as well as most parts of the world is highly regulated, most transparent and user friendly. With one click of a button, you can withdraw your entire amount and your bank account is credited with the proceeds next day (for liquid funds) or next 2/3 days (for equity and Income funds).

      • Dear Vipin,

        I wish I would have come across the right advice from a person like you much earlier,
        I have 2 policies, namely HDFC Unit Liknked Pension Plus & HDFC Unit Linked Pension II.
        In the first plan I was to pay 2 installenets of Rs. 10Laks each in first year. Thereafter Rs 10,000/- every six months. I have been paying the premium regularly. Present corpus in policy is about Rs. 50 lakhs.
        In case of HDFC Pesion II plan, I have paid premium @ Rs. 65000/- per month for 3 years. Now the accumulated fund is invested in Equity & Balance in ratio of 75:25.
        In both the cases, I was told by the agent that after 3 years I can withdraw the accumulated amount underthe policies without any tax implications.
        Last month I approached the office of HDFC Life to surrender my policies. I was told that entire surrender value of the policies will be taxable. I have not availed of any tax benefits while paying premiums.
        I seek your advice how to move forward in the matter. Should I surrender both the policies, pay tax @30%+ & invest the balance amount in equity related benefits
        OR wait till the date of maturity( Nov. 2018), receive 1/3 of the accumulated amount as tax free & buy annuity with the the balance 2/3 of the amount.
        Thanking you

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