Best Retirement Planning Investments
GAURAV KANSAL
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Retirement is a
complex but a very important topic, especially in today’s context as our
country is going through a process of economic and social transformation. It is
imperative for us to plan for retirement early in our working lives.
Unfortunately in our country, retirement planning is not given the due
importance that it deserves. While there is a lack of financial planning for
retirement discipline in India, the universe of retirement planning options is
also very limited. Traditionally employee provident fund, public provident fundand life insurance policies have been the
investment options commonly associated with retirement planning in India. All
these investments are seen as risk free investment, and retirement planning as
such in India is usually associated with these investments. These investments
also enjoy tax saving benefit under Section 80C of the Income Tax. However, there
are two other eligible investment options under Section 80C, which are more
suited to retirement planning especially for young investors. These are
the National Pension Scheme and Equity Linked Savings Scheme (ELSS).
In this blog we will discuss the best retirement planning investments for young
investors.
At the outset, we
should discuss the objective of retirement planning. The fundamental goal of
retirement planning is to achieve financial independence in your retirement
years and to be able to maintain your current lifestyle after retirement. If
you save a portion of your income and invest it, you should be able to
accumulate your retirement corpus. If you are young, you have the advantage of
saving and investing over a long period of time and therefore you will be able
to accumulate a bigger corpus. So what is the big deal? Let us walk through an
example with numbers and hopefully you will understand, it is not as easy as it
sounds. Let us assume you are 30 years old. You will retire at 60. Your current
income is र 10 lacs per year. Let us assume that,
your basic salary is 50% of your gross salary (it is usually in the 40% to 50%
range). You contribute 12% of your basic salary to Employee Provident Fund.
Your employer makes a matching contribution. In addition, let us assume you
will save another 10% of your gross income for retirement planning. Let us
further assume that you get a salary increment of 10% every year. The chart
below shows how much you will save till your retirement.
If you get a return of
8% (compounded) on your savings, you will accumulate a corpus of र 8.1 crores at retirement. It is
impressive so far. Let us now see, how long this amount will last after your
retirement. Here we come back to one of the key objectives of retirement
planning, which is to maintain a certain lifestyle. Let us assume you want to
maintain the lifestyle you had towards the end of your working career. Assuming
you get 8% pre tax returns on your retirement savings, your corpus will last 10
years at best. It does not look that impressive any more. But it is about to
get worse, once we factor the ugly 9 letter word, inflation. Factor in 5%
inflation and your corpus only about 7 – 8 years. Retired lives can be as long
as 25 to 30 years. In this example, you are losing your financial independence,
even before you reach the half way stage of your retired life.
So what is the solution
You can save more
towards retirement. However, you will agree with me that it is easier said than
done. Inflation and taxes take out big part of our income. Home loan EMIs take
out another big chunk. Then you have other investment goals as well, like
children’s education, marriage etc. Saving more towards retirement is,
therefore, not always feasible. The solution lies in getting better
returns on your retirement planninginvestment and
that is the crux of this blog. If instead of 8% returns you get 15% returns,
your retirement corpus will last for around 20 years instead of 7 – 8 years. Is
it possible to get 15% return on your investment? The answer is yes. Let us
review the various retirement planning investment options under Section 80C.
Why restrict the retirement planning options
to 80C investments
There investment
options outside the Section 80C universe. But that is the topic of
another discussion. Tax savings under Section 80C is definitely a big incentive
for making retirement planning investments. As your income increases,
investments within the 80C limit of र 1.5 lacs per year will not be
sufficient. But you can always invest more than 80C limit. Let us now look at
the various investment options.
Voluntary Provident
Fund: You can make
voluntary contribution to your provident fund account. You will get interest of
8.5% on your contribution. You cannot withdraw till your retirement. However,
you can get loans under some circumstances. The maturity proceeds are tax
exempt.
Public Provident Fund
(PPF): You can make
deposits to your PPF account. PPF
interest rate is currently 8.7%. However, the rates may vary since it is been
pegged to 10 year Government Bond yield. The tenure of this instrument is 15
years, and is extendable in blocks of 5 years. Withdrawals not exceeding 50% of
4th year balance are permitted after a lock-in period of 7 years. PPF also
offers loan facilities. The maximum and investment under PPF is र 1.5 lac and Rs 500/-. The maturity
proceeds are tax exempt.
Life Insurance
Policies: Life insurance premiums are eligible for
tax savings under 80C. You get life cover and survival benefits on completion
of the policy term. There are two kinds of life insurance plans, traditional
plans and unit linked plans. Traditional endowment plans have historically
given 6 – 7% internal rate of return. Unit linked plans are market linked
instruments. In addition to providing life cover, a portion of your premiums
are invested in purchasing units of a fund of your choice. On an average equity
oriented ULIP funds have given 15 – 18% annualized returns over a 10 year
investment horizon. However, your effective returns can be much lower because
of your premium will go towards the mortality charges (life cover) and various
fees like premium allocation, policy administration, fund management etc. These
fees are deducted from your premium and only the balance amount is invested in
the units of the fund. In the initial years of your policy life as much as 10%
of your premium can go towards these fees and not be invested to buy units.
National Pension
Scheme: National Pension Scheme (NPS) is
open to all citizens who want to invest for retirement. It is defined
contribution pension system where the investor makes contributions on a regular
basis. It is a market-linked product which does not guarantee returns. It is
low cost product (fund management charges are capped at 25 basis points). To
invest in this scheme you need to apply for a permanent retirement account
number (PRAN), through point of presence service providers. Once you receive
you PRAN card, you can invest in a fund of your choice. There are two types of
NPS accounts. Tier 1 account is mandatory and qualifies for 80C tax savings.
There is a minimum contribution amount for Tier 1 accounts. This account does
not allow premature withdrawal. Tier 2 account allows premature withdrawals
under certain circumstances and does not qualify for 80C tax savings. In the
2015 Budget an additional tax deduction of र 50,000 has been allowed for NPS
contributions under Section 80CCD. This is over and above the र 150,000 tax savings allowed under
Section 80C. The average 3 year annualized returns of Tier 1 and Tier 2 equity
plans is around 15%, whereas the average 5 year annualized returns is around
8%. The maturity amount of NPS is not tax free. We will discuss this in more details
later.
Equity Linked Savings
Scheme (ELSS): ELSS is a mutual fund scheme that
qualifies for tax savings under Section 80C up to a limit of र 150,000. An ELSS is essentially a diversified equity scheme with
a lock in period of three years from the date of the investment. Capital gains
in ELSS are tax exempt. Dividends paid by ELSS are also tax free. If you invest
in an ELSS through a systematic investment plan (SIP),
each investment will be locked in for 3 years from their respective investment
dates. Compared to other retirement planning investments under Section 80C ELSS
offers higher liquidity and potentially superior post tax returns. However, as
with all mutual fund investments ELSS are subject to market risk. ELSS funds
have given an average 20% trailing annualized returns over the last 3 years,
10% annualized returns over the last 5 years and 12% annualized returns over
the last 10 years. Compared to NPS, ELSS funds on an average have given higher
returns. The difference is even bigger if you compare the performance of top
performing ELSS funds with their NPS counterparts. While the top performing NPS
fund has given 15.7% trailing 3 years annualized returns, the top performing
ELSS has given over 30% trailing 3 years annualized returns. A major advantage
which ELSS enjoys over NPS is the tax treatment on maturity. While capital
gains in ELSS are tax free, NPS maturity amount is taxable on withdrawal. The
other problem is that, under the current rules, 40% of the NPS maturity amount
must compulsorily be used to purchase annuities and the annuity income is
taxable. There are also limits on equity allocations in NPS, which younger
investors may find too conservative relative to their risk profile.
How can ELSS help you create a retirement
corpus
Let us see how much
wealth could have created in the last 15 years from FY 2001 to FY 2015 by
investing in ELSS versus a risk free investment like PPF. For our analysis we
have assumed an annual investment of र 70,000 in FY 2000 – 2001, र 100,000 from FY 2001 – 2002 to FY 2013 –
2014 and र 150,000 in FY 2014 – 2015, as per
Section 80C limits for the respective years. Let us first see how much maturity
amount one would have accumulated in the last 15 years by investing up to the
maximum 80C investment limit in PPF. The chart below shows the cumulative
deposit amount and value of the investment in PPF.
The blue line shows
the cumulative deposits made by the investor in his or her PPF account every
year. The total deposit made by the investor is र 15,20,000 (र 15.2 lacs) over the duration of the PPF.
The red line shows the value of the PPF account, inclusive of accrued interest.
The maturity amount of the investor is about र 29,82,000 (around र 29.8 lacs).
Let us now see how
much corpus would an investor have accumulated by investing up to the maximum
80C investment limit in ELSS. In this example,
we have chosen an average ELSS fund which completed 15 years. The chart below
shows the cumulative investment amount and value of the investment in ELSS.
The blue line shows
the cumulative deposits made by the investor in the ELSS fund every year. The
total investment made by the investor from 2000 – 2015, is र 15,20,000 (र 15.2 lacs), the same amount deposited in
PPF in the previous example. The orange line shows the value of the ELSS investment
based on prevailing NAVs. As we can see from the chart above, the ELSS returns
are of a very different order of magnitude compared to PPF. In fact, the
current value of the first two ELSS investments made in 2000 and 2001 itself is
much more than the total maturity amount accumulated in PPF in the previous
example. The value of the ELSS investment as on Apr 2, 2015 is over र 1.15 crores, nearly four times the PPF
maturity amount. The internal rate of return (IRR) is well over 20%.
Is it possible to similar returns from other
investment options
Historically, we have
seen that equity as an asset class has given the highest returns over a long
investment horizon. You could get returns similar to what ELSS has given by
investing in diversified equity mutual funds.
However, by investing in ELSS you can get the added benefit of tax savings
under Section 80C. If you have invested the maximum amount allowed under Section
80C in ELSS, then you can invest in diversified equity funds or you can
continue to invest in ELSS.
Conclusion
In this blog we have reviewed various retirement planning investment options. For
young investors equities should form a major portion of your asset allocation. As such ELSS is one of the
best investment options for retirement planning, as far as young investors are
concernedThanks
Regards
Gaurav Kansal
9313368533
Source: Advisor Khoj
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