Pension - The Do It Yourself Guide

Pension is the salary you get after you have ceased to work, if you have been

working for the government, or so we normally assume. But that is no longer entirely

true. Pensions are paid by some other employers too; and people retire early, to pursue

their other interests. Moreover, the market is full of pension schemes now, where you

can pay yourself a pension as and when you want : you contribute to create a pension

corpus, and then draw a pension from it. Well, now there is not much of a difference

between these and the employer paid pensions. Most of the latter have now become

defined contribution pensions your pension depends on the corpus created by your

own and your employers contribution.

All pension contributions are eligible for rebate from income tax under sections

80C, 80CCC and 80CCD. Whatever you contribute can be deducted from your taxable

income, subject to a limit of `1,50,000 (along with other specified deductions under

section 80CCE). Often, tax saving is what leads us to Pension Schemes. What you need to

note here is the fact that this is not really tax saving; it is mere tax postponement.

Because, when you draw your pension, you pay tax on it, just as you would have paid on

your salary. It is even worse. Your pension every month will be made up of (a) what you

have earned on your pension corpus, and (b) a part of what you had contributed to the

pension corpus. Now the second part (part b) is not your earnings/income; it is merely

your capital being returned. If this part comes from pension contributions for which you

have fully availed of section benefit, you can look at it as tax postponement; but if the

contribution has gone from your taxed income, then it is double taxation.

If that is the case, why not steer clear of anything called pension, and create your

own source of income for the sunset years ? You can; and you can do it pretty efficiently;

even tax efficiently. But before we come to how to do it, let us look at another aspect of

pension which is rather catchy.

Pension, as we said before, is the income you get after you have ceased to work

and earn. This income has to come from the corpus that you have created when you

work and earn. Once you start drawing the pension, this corpus is a fixed amount. If you

draw more out of it every month, it will last for a shorter time you will get pension for

a shorter time; if you draw less out of it every month, it will last for a longer time you

will get pension for a longer time. Ideally you would like to have pension for life time,

that is, till you die. That is a big problem. How do you solve that problem ?

If you do your own pension outside a formal pension scheme, you cannot solve

that problem. What a Pension Fund (which runs the formal pension scheme) does is, it

uses the pooling principle; just the way an insurance company does. In case of

insurance, those who live longer pay for those who die early; in case of pension, those

who die early pay for those who live longer. In other words, your pension comes from a

common pool of pension corpuses, not just your own corpus; so it does not matter how

big your pension corpus is with respect to your life.

So the choice is between avoiding double taxation, and the risk of running out of

pension. Of course, the growth of your pension corpus when you create it in the manner

we are going to see below is likely to be faster, than when you leave it to a Pension

Fund. The reason is simple; the Pension Fund juggles between returns on your

investment and the risk on your life; when you create your own pension corpus, you do

not have this jugglery to do (simply because you cannot do it); you focus on return and

leave the risk of living too long to luck.

Now, let us come to the modus operandi of creating your own pension corpus. You

can do it in many ways. You can simply put your regular contributions into a bank

Recurring Deposit, and then draw pension from the accumulated amount. Or you can

invest in equity shares regularly and create a portfolio. When the sunset years come,

you can liquidate your portfolio from time to time. But the modus that I prefer, and

which I suppose is just right for most of us, is to start a SIP (Systematic Investment Plan)

in one or more equity schemes of Mutual Fund/s. The schemes should have been

around for some time so that you can evaluate their track record; they should be fairly

diversified, without any bias towards any particular industry or trend; they should be

investing in well-established mature companies, without taking bets on any

opportunities. In other words you are looking at modest, steady returns. Run the SIP

till the time comes for you to draw the pension.

When it is time to draw the pension, stop the SIP and start SWP. SWP is Systematic

Withdrawal Plan. This is an instruction that you give to the Mutual Fund to credit to

your bank account a fixed amount every month. Thats like your pension getting

credited to your bank account every month.

A question that may bother you is : Is it not risky to invest in equity for creating a

pension corpus ? What if ? Well, the risk is always there; but as compared to the risk

of life (anything can happen to you at any time) this risk is of a much lower magnitude.

In other words, equity is fairly safe if the investment horizon is of 20 years or longer.

And that is the horizon you are talking of, when you are thinking of pension. You have to

plan for your pension at least 20 years before you are likely to retire. Ideally I would say

the contribution to the pension should start from the very second year of your

beginning to earn. Does not your employer cut your pension contribution from your

salary from around that time ?