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What is Pension - Pension Meaning and Definition

dateKnowledge Centre Team dateJune 01, 2022 views180 Views
Meaning of Pension | How does it Work

A pension is a fixed retirement fund for an employee paid as a regular income at regular intervals during his post-retirement years. A pension is a fund where a sum of money is added by the employer, employee, or both.

A pension is a testament to your retirement plan during your employment years. Retirement is your second inning during which you want to fulfil your long-awaited dreams and spend time with your loved ones. However, you can only do it if you prepare for it. Your pension defines the quality of your retirement. To secure your post-retirement life, you need to start thinking about the pension.

Once you retire, a pension is your major source of income and your savings at the time of retirement will ultimately define it. Also, you don't know how long you are going to live. You must have an adequate corpus and a recurring income.

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What is Pension?

Pension is the regular monthly income you generate out of your saved corpus, usually after retirement. You build the corpus usually, during your active employment. Your employer may also contribute to your retirement corpus.

Upon retirement, you can invest a part of your retirement corpus into a pension or annuity plan. The plan allows you to safely invest your precious retirement corpus for a long time, even for a lifetime. The plan will then start offering you a regular monthly or quarterly income.

You can also choose to have a growing pension to compensate for inflation.

How does a Pension Plan Work?

A pension helps you generate regular income after your retirement. The working of pension is different and varies from plan to plan. However, the underlying working is the same.

You invest an amount in a pension plan regularly over the years, and it grows to create a sizable fund for you. Upon retirement, you can use the created corpus to buy an annuity, and based on the plan you have selected, you start receiving the pension.

Types of Pension Plan

A pension scheme or plan helps you focus on yourself post your retirement. With a regular income, you do not have to worry about the money and can focus on things you love doing. There are different types of pension plans you can invest in to receive the pension after you retire.

1. Annuity Plans

These are pension plans that provide you with a regular income stream. You buy an annuity plan and pay a premium amount or make a one-time lump sum payment to the insurance company. The insurance company, in return, pays your regular income. Depending on the type, an annuity can start immediately or on a future date.

Definition of Annuity Plan

2. Social Security Schemes

The Government of India offers a variety of social security schemes, including pension schemes that help you invest today to secure your future. One example is the Atal Pension Yojana. You invest a certain amount in the scheme, and you receive a guaranteed pension after 60 years of age.

3. Deferred Annuity

A deferred Annuity is a type of pension plan where the pension starts a few years from the investment. For example, you can invest Rs 10 lakhs now and the monthly income will start five years later.

4. Immediate Annuity

An immediate annuity is a pension plan where your monthly, quarterly or yearly annuity starts with the investment. For example, you invest Rs 10 lakhs and start to receive a monthly pension after 30 days of investment.

5. Annuity Certain

Annuity certain is the type of annuity plan which provides regular income for a limited period. For example, investing a lump sum money to receive a fixed income for 10 years. At the end of the term, you will receive the remaining balance.

6. Pension Plan with Life Cover

These are pension plans where primary account holders or joint holders will also have a life cover. If they die during the plan’s term the policy will pay the death benefit amounts to their nominees.

7. Life Annuity

A life annuity can be a deferred or immediate annuity which will continue to pay income until the demise of the policyholder. Upon the death of the policyholder, the balance funds are paid to the nominee.

8. Guaranteed Period Annuity

Guaranteed period annuity refers to the annuity which will continue even if the policyholder dies within the guaranteed period. Usually, other annuities require the policyholder to submit a proof of living every year to continue receiving an annuity. A guaranteed period annuity releases you from the obligation at least for a few years.

Read more - Is Pension Taxable?

How to Build Corpus for your Retirement with a Pension Plan?

To build a corpus for your pension, you can invest in one or more options available to you. You can select the ones that are in line with your financial needs:

1. National Pension Scheme (NPS)

You can open an NPS account and invest in them while you are working. Your investment is divided into equity and debt and grows over time. On maturity (60 years), you can withdraw up to 60% of the accumulated corpus in a lump sum. You need to buy an annuity plan with the remaining corpus which helps you generate regular income.

a) Life-stage portfolio allocation
b) Exposure to alternative assets
c) Choose from aggressive to safe portfolios
d) Benefit from market-linked returns

Learn more about National Pension Scheme.

2. Public Provident Fund (PPF)

This provides you with secured returns over the long term and gives you a great investment option for building a corpus for pension. You have to remain invested in these schemes for 15 years.

a) Tax-free growth and maturity value
b) Partial withdrawals are allowed from the sixth financial year of investment
c) Extension in batches of five years after maturity

3. United Linked Insurance Plan (ULIP)

If you are looking to grow your retirement corpus aggressively, you can opt for ULIP as it lets you invest in stocks, bonds, and other financial instruments. You also get life insurance, and the premium you pay is eligible for a tax deduction.

a) Hold up to 99 years of age
b) Partial tax-free withdrawals are possible after five-year lock-in
c) Invest in aggressive and safe portfolios
d) Manage your allocation automatically
e) Bonus additions for long-term investors
f) Safety of life cover for family members

How to Choose the Best Retirement Pension Plan?

The right time to start planning for retirement is as soon as your start earning. You can choose the best retirement plan based on the below parameters:

1. Time to Retirement

The first and the most important thing to consider is your retirement age. Some people want to retire at 60, while others want to retire earlier. Knowing the years before your retirement helps you choose the right pension plan.

2. Inflation

The money you are investing today should be sufficient to help you live the life of your choice post-retirement. Inflation reduces your purchasing power and lowers the value of money. Your pension plan should grow at a rate higher than inflation.

Why should you consider inflation while planning for retirement.

3. Asset Allocation

Different individuals have different risk profiles. Your pension plan should allow you to choose your asset allocation. If you are starting early and your retirement has time, you can be a bit aggressive. As you come close to your retirement years, your pension plan should allow you to move your assets to safer options.

4. Added Benefits

You can plan for retirement, but there can be some unexpected events in life. Your retirement plan should cover you and your family from unexpected life events through added benefits like life cover and protection against illnesses.

For example, ULIPs like Invest 4G from Canara HSBC Bank of Commerce Life Insurance offer bonus additions for long-term investors.

5. Same Plan to Draw Pension

Once you have created a retirement corpus, you have to start a pension. Your pension plan should have the feature to convert your corpus to a pension. If not, you will have a tough time deciding how and where to invest the accumulated corpus for the pension.

For example, you can use both Invest 4G ULIP and PPF for tax-free partial withdrawals.

6. Taxability

Last on the list, but every essential parameter to consider is taxability. The premium (investment) you make towards your pension plan should be eligible for a tax deduction.

At some point, you will have to retire. If you don't want to worry about your financial needs post-retirement, you need to invest in pension plans. The sooner you start planning for retirement, the easier it gets. Pension gives you financial security and the freedom to live your life the way you want to.

Disclaimer: This article is issued in the general public interest and meant for general information purposes only. Readers are advised to exercise their caution and not to rely on the contents of the article as conclusive in nature. Readers should research further or consult an expert in this regard.

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