Why to avoid investing in life insurance - pension plans?

In my previous post, I have discussed various methods to build retirement corpus. I was just reading a report on a Mutual fund past performance and thought to share it with you all. It made my old belief “Insurance is for life cover, not for investment” true. It is about the Birla Sun Life Tax Relief 96 Fund. If you would have invested Rs. one lakh in Birla Sun life TAX Relief 96 Fund in March 1996, than you would have received Rs. 21 lakhs as dividend in 12 years (Between year 1996 - 2008) & its current value is approximately 4 lakhs; even after recession and market crash. So in total you would have received 25 lakhs. I don’t think, if it is possible in any pension plan of any life insurance company.

How to build retirement corpus?

Never put all your eggs in one basket. So diversify your investment in three parts - short term, medium term and long term. Pension plans aren't the only way to build a healthy corpus for retirement, notwithstanding the fact that they contain the word 'pension'. In fact, a combination of Public Provident Fund (PPF) and tax-saving mutual funds(ELSS) can work much better in this regard. So today, I take some investment options for retirement -

PPF -

PPF account matures 15 years after the financial year in which the investment was started and can be extended thereafter. When you withdraw the accumulated corpus, it is totally tax-free. The maximum amount that can be invested in PPF every year is limited to Rs 70,000. The remaining can be invested in other investment options.

ELSS -

ELSS come with a lock-in of three years. The main benefit with ELSS is that if the investor sees that his tax-saving mutual fund is not doing well, he can easily switch to another scheme after three years. If you withdraw after three years, it is totally tax free.

Those who are more risk taker can invest more in tax-saving mutual funds and less in PPF.

MFs -

If you have more money left with you after investing 80C’s 1,00,000 limit, than go for mutual funds. The mutual funds are for short term as well as for long term. There is flexibility for investor to opt to switch from one scheme to another without any exit load after 6 months.

Stocks -

Equity is most important investment option, if one wants to create wealth. But at the same time the risk is very high. So always invest in top stocks and that too for long term.

Bank FDs -

Easiest and safest option. Less risk, so less return. But as a to diversify your portfolio, invest some part in FDs. If you invest for 5 years in Bank FD, you would also get tax rebate under section 80C.

Do Pension plans are good for short term?

Pension plans offered by insurance companies are for long term. It gives you two time tax saving, once when you are investing and second when you are withdrawing the pension fund and buying annuity.

Tax Rebate Structure for pension plans

Earlier, investments into pension plans used to get a maximum deduction of Rs 10,000/- under Sec 80 D. So effectively, we can claim the tax rebate of Rs. 1,00,000 + 10,000 (Old Sec 88 + Sec 80D). Now, all the investments (ULIP, Pension plan, ELSS, PPF, National Savings Certificates etc) up to Rs. 1,00,000/- are exempt under Sec 80 C. So now no separate tax benefit of investing in pension plan.

The Income tax works differently, when investor decides to get out of the plan midway or holds on till maturity. Suppose after few years down the line, your pension plan has not been performing well in comparison with other plans in the market. Than you would think to get out of the plan. But, here is a catch, you have to pay a price.

1- Midway -The insurance company charge a surrender fee. As per the current tax laws, the investor will have to pay tax on the entire amount the insurance company pays him.

2- Part corpus at maturity - As per the current income tax rules, the investor is allowed to withdraw one-third of the corpus tax-free. The remaining money has to be used to buy immediate annuities. This means that the investor will have to buy immediate annuities even when other kinds of investment might give him a greater return.

3- Entire corpus at maturity - The only way out is to surrender the policy. But again, the problem is that on surrendering the policy, the entire corpus will be taxed at the prevailing tax rates.

Returns of immediate annuities

Currently post-tax return on immediate annuities has been lesser compared with other sources of regular income such as the PO Monthly Income Scheme, Senior citizens fixed deposits etc.

So pension plans are for long term and safe investment. If you exit before the term, you would not get much return. So if you are looking for short term in pension fund... please avoid.