Should you go for a traditional or a unit-linked pension plan?

Traditional pension plans offer a minimum guarantee, but higher exposure to equity in the case of Ulips could be more beneficial over the long term

Pension plans of insurance companies should carry a warning---when it comes to retirement planning, these are more expensive and don't offer the tax benefit of instruments such as Public Provident Fund (PPF) and National Pension System (NPS). PPF is exempt from tax at the investment, accrual of interest and withdrawal stages, while NPS is cheaper (the commission paid to fund managers is just 0.25 per cent).

In the case of pension plans from insurance companies, the annuity paid is taxed at the hands of the policyholder. And, the commissions and charges are higher than NPS. But if you have invested in PPF and NPS and still want to save for retirement, you could consider pension plans. These help you accumulate savings and build a retirement corpus. A third of this corpus is commuted, meaning it is paid to you on maturity. This amount is tax-free. The rest is used to give you regular income through an annuity plan; this income is taxed.

By providing a tool to accumulate and invest your savings, these plans give you a lump sum on retirement, then used to get regular income through an annuity plan. Given the high cost of living and rising inflation, employer pensions alone aren't sufficient.

Within pension plans, there are unit-linked and traditional ones. The basic difference between the two is the kind of instruments these invest in. So, how does one decide which is best for him/her?

Traditional plans are more oriented towards investment in debt funds, as these have a certain guaranteed sum assured for policyholders at the end of the tenure. "A major part of their investment, about 60 per cent, is in government securities. That is why it may not be possible for a traditional plan to give returns that beat inflation," says Prakash Praharaj, founder and chief financial planner of Max Secure Financial Planners.

In the case of a unit-linked or market-linked pension plan, a policyholder can choose the investment limit he/she wants for equity investment. But market risks are involved, as the investment is linked to equity markets. "If you are starting your retirement planning early, you could go for Ulip (unit-linked insurance plan) pension plans, as these would give better returns. Traditional plans wouldn't give very high returns because of the cap on investments prescribed by the regulator," Praharaj says.

According to Anuj Bhagia, chief marketing officer, Policybazaar.com, Ulip pension plans are preferred. "They allow the policyholder a choice of funds, along with investment in equities, which helps in faster accumulation of funds with growing markets," he says.

Ulips also give the policyholder an option to switch between the investments (debt and equity) three to four times a year. But this would help only if a policyholder understands the market risks and is able to switch at the right time.

According to Insurance Regulatory and Development Authority guidelines, both traditional and Ulip pension plans have to provide minimum guaranteed returns, as these are aimed at building retirement corpuses. Traditional plans guarantee a minimum sum assured, along with bonuses, if any, while Ulips provide a minimum guarantee of about 4.5 per cent.

"Ulip plans go through the vagaries of the stock market. So, the returns may not be as high as expected, while traditional plans, with their debt outlook, are a more trusted partner, though these have slow wealth accumulation. Therefore, as an investor, I need to know what product I would want to purchase, according to my appetite," says Bhagia.

As bonus is discretionary, not mandatory, customers choosing a traditional plan should look at the past record of companies in paying bonuses, says Sanjay Tiwari, vice-president (strategy and product), HDFC Life. The company offers both Ulips and traditional pension plans; there are sets of customers for both.

Another advantage of Ulip plans is the option to top-up or increase your investment. This could help inflate the investible amount, which, for a pension plan, is beneficial to build the overall corpus through the long term, Tiwari adds. For a traditional plan, there is no such option.

Amitabh Tapadar, chief marketing officer, Tata AIA Life Insurance, says while equity gives better returns through the long term, according to the new regulations, insurers have to give a non-zero guarantee, even on Ulip pension plans.

Therefore, there are chances companies offering Ulip pension plans would also invest substantially in debt market, as the equity exposure is limited. Hence, their returns might be less than in the case of pure equity investments.

In terms of costs, Ulip plans score over traditional ones, owing to transparency. Traditional plans are cost-heavy and opaque, unlike Ulip plans, for which all charges are confirmed to the consumer upfront. But a few insurers charge a guarantee fee for Ulip plans.

One should check these before purchasing a plan, Bhagia says. Customers should also look at the history of the insurance company, in providing annuity service, as it is now mandatory to buy the annuity from the same company one buys the pension plan from.

TAKE YOUR PICK

• Since equities give good returns over the long term, Ulip pension plans are beneficial if you start before retirement
• Charges and expenses are more transparent in Ulips
• Traditional plans give minimum assured returns but these might not beat inflation
• Check history of insurer with regard to bonus, since it is discretionary and not mandatory