Retirement funds, or pension funds, are types of financial instruments designed to help individuals accumulate a portion of their salary for the post-retirement years.
Periodic savings from income earned during working years lead to a significant collection that provides an income stream at retirement. These funds normally offer pension payments until death.
A pension fund invests in a variety of financial instruments, but to gain stability, it focuses more on low-risk instruments such as government securities.
However, to generate potential growth, it may also have a balanced mix of equities and debt. These returns are reinvested and therefore add to the fund’s growth over time.
Lock-In period
The lock-in for many retirement funds is compulsory, five years or up to the age of retirement.
Some have the interest rates up to 11%, depending on the specific policy and the investment strategies adopted. Retirement planning is fairly more reliable due to this fact.
Investors can invest their retirement funds either as a lump sum or through some form of systematic investment plan (SIP).
after retirement investors can withdraw systematically so that the availability of money is without the problem of lack of liquidity.
Features of a Retirement Fund
1. Lower Risk
Retirement funds, which include pension plans and retirement mutual funds, are generally low-risk investments. This type of fund invests in low-risk assets that can yield regular returns, including government bonds and securities.
2. Withdrawal Flexibility
Retirement funds prevent any withdrawal until 58 to 60 years of age. However, an investor can withdraw it as a lump sum at retirement or receive a monthly payment after retirement.
3. Lock-in period
Most retirement mutual funds have a lock-in of five years, and in the case of (Equity Linked Savings Scheme) ELSS funds, it is for three years. The greater the lock-in period, the better it gets as it helps your investment grow through compounding and smoothes out short-term market fluctuations.
4. Hybrid Investment Plan
Hybrid schemes are some plans that invest in the debt and equity markets. Controlling risk, most of these hybrid plans limit the exposure to equities at around 40 to 50% with maximum growth potential and with stability.
Why Should You Invest in a Retirement Fund?
They are long-term savings plans, either monthly pay out or the lump sum disbursement of the funds. These retirement funds create income that even can be further invested upon.
The investor can seek a lump sum amount or a monthly amount according to his financial needs and goals.
Annuity Plans
An Investor can even opt for a deferred annuity plan to secure a higher corpus in post-retirement years. Most pension policies act as a life insurance cover, which would protect an insurer from any financial loss in case of their demise before retirement.
It also allows the investor to withdraw a lump sum amount in case they face any medical emergency. This can prove beneficial to pay for long-term health care and is an important feature of pension funds.
Protection against Inflation
Pension plans are the most widely used means of protection against inflation. Most retirement plans offer some form of compensation for inflation, and dispense one-third of the amount collected at retirement, and the remaining two-thirds as a monthly annuity for the investor.
Low Risk Advantage
Mutual fund retirement plans are one of the safest ways of investment as they have an extremely low-risk profile.
Investors also have the option to put their money in government securities for an assured return or invest in debt and equity to earn better returns.
The risk is suitably balanced with the prospect of return and an individual’s risk appetite.
Taxation Rules of Retirement Fund
Any contribution towards retirement mutual funds is tax exempted up to a maximum amount of Rs. 1.5 Lakh under Section 80C. However, the withdrawal is deductively taxed. Since money is distributed in the form of an allowance, this will attract tax at the rate prevailing at that time.
Periodical pension is fully taxable, just like the policies levied on an individual’s salary. However, if an individual chooses to take the total amount post-retirement, the taxation policy may change.
Government employees, including those in the armed forces, will be exempted from all taxes during disbursal.
There are only partial exemptions from paying tax to the employees of non-government agencies up to certain limits. In cases where gratuity is accumulated with the pension, one-third is exempted.
For the others, half of the total amount in the fund is exempted from paying taxes. A monthly allowance disbursed as pension by any family member is taxed as income derived from other sources.
But, it is exempted to a certain limit; that is, up to Rs. 15,000, or one-third of the monthly allowance, whichever is less, is exempted from taxes.
But, if the individual prefers the total retirement fund for disbursal, it is totally exempted from all kinds of taxes.