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Financing Retirement Plan

The options for Individuals

here can be a list of the options of the various plans that are in operation in a country. However, this is just the start of the process because all the options might not be present for an individual. Even if you start on the process there is a long way to go, as it becomes a tough task for a person to know and remember the details of each of these plans. In real life, a person cannot just avoid this area because it is too difficult to handle. This will have to be tackled in one way or the other. In addition, the importance will rise because the entire retirement planning funding decisions depend upon these routes. Before deciding upon the list of the various options present, there is a small bit of check that one has to run so that there is no confusion in the entire process of retirement planning. The checks are: The final aim of the retirement planning process has to be clear. This requires that the goals are set. The ways in which the goals are to be met have to be decided. Factors that affect an individual due to the specific circumstances have to be considered. These have to be listed out and then planned for. The existing situation on the planning front has to be known and evaluated. This will give an idea of the changes that are required. Additional work required will also be known. The funding options chosen can then fit into the overall plan. There are several options present for the individual both in terms of Defined Benefit as well as Defined Contribution Schemes. The ones which an investor will select and then implement for their use depend upon conditions relevant to the individual but there are certain factors that will influence the decision. The factors are: The nature of income of the individual in terms of salaries, professional fees etc. If there is income from more than one source, the break up of this amount. The kind of employer, if there is income from salaries for the individual. Savings of the individual. The target or the goals that have been set. The need to generate a certain kind of return from the investments. The extent of income that has to be generated. The type of investments required.

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Provident Fund Let us look at what can be chosen by an individual and how this will help them in the planning process. The most common choice for the individuals in the cities will be the Provident Fund (PF). This is because a lot of people in the cities of the country are employed and their employers are covered under the provident fund Act. The features of those who are covered under the provident fund will be: There will be a regular deduction each month. There will be a contribution from the employer. Interest will be earned on the investments. The employee will get a provident fund account statement each year. The contribution is available as a deduction from income under Section 80C so individuals like this form of investment that also saves tax. This is a direct payment so there is no need to remember and take the effort to invest each month. The earnings also do not come in the tax net and hence, there is an advantage in building up a good corpus. There is a need to take guard to see that the fund is being managed in the proper way. This becomes the backbone for a large number of people in terms of the planning for retirement purpose. The money can accumulate and will then be received at the time of retirement. There are also people who are employed or who work for someone else but do not have the benefit of a PF. The target for these people should be to put away some money each month and build their retirement nest. The idea behind the entire process is to see that the accumulation process can work and the benefit is seen in the later years. At the same time, there are few factors that one should be alert about in the usage of the PF because of the fact that this can undermine the entire efforts taking place: There is a tendency for a lot of people to borrow against the PF leading to a loss of the advantage built up. This leads to no accumulation of capital. The loan dilutes the actual reason for the saving. Many look at this route as a tax saving measure only but adequate emphasis is also required on the capital accumulation part. This builds up the debt part of the portfolio but still there is a limit to the investment and there is little that can be done about it. Many people also voluntarily put in additional sums, which is good for saving but this might not always be the best route from the asset allocation point of view. This should not be the only mode for retirement planning. For those who are covered under the Employees Provident Fund act, there is an additional benefit because the pension scheme contribution comes along with the provident fund. This applicability, where necessary, might not result in any tangible benefit. This is because a lot of people will find themselves excluded from the actual use of these additional schemes or the amounts might be so small that they might not be useful for the planning of an individual. These are factors that have to be considered in the planning process.

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Tax Angle There is a lot of importance given to the Tax Angle as this can change the entire situation on its head. The tax impact for various items related to the provident fund have been covered in the respective area. However, if the investment is withdrawn within five years of the start of the fund then this is taxed at the time of receipt. This requirement of five years can be met by transferring the provident fund from one employer to the other when there is a change of jobs so that the continuous period is not interrupted. Not Applicable Some of the provisions like the Industrial Disputes Act or similar such acts might not be useful for someone who is practising. The mix of the clients that a person has will determine the use and the applicability of several laws. Thus, there might be times when several laws might not be useful in the actual process of use. Public Provident Fund (PPF) PPF is another route that is used quite extensively by people. The advantage of this route is that since it is a 15 year scheme with the possibility of extension, there can be long term planning with the use of this scheme. The restriction of the investment means that there is a limit to which the scheme can be useful for the individual. There is also the investment benefit of a tax deduction for the employee under Section 80C and this is an added advantage that the individual can make use of. The main features that are useful in the line of implementation are: This is a long term product. It can be planned to mature at the right time. The income is tax free at the moment. The interest rate is compounded at 8%. A build up in the initial years helps the individual to earn a significant sum each year. The earlier the amount invested during the year, the better it is from the earnings point of view. There is a tax benefit on the investment. Again, if the PPF account is not used for the purpose of accumulation by taking a loan and making various withdrawals then its purpose is defeated. This would mean that there is no build up of the capital that is so essential for retirement The PPF account has to be used to the maximum extent based on the present rules. Things are however not rosy on all sides and there can be some problems as far as the PPF scheme is concerned. The change in the interest rates can impact the expected earnings. Further change in the tax laws can also have a severe impact. The limit on investment hinders the accumulation process. A special mention has to be made of the change in the tax laws. There is a proposal to introduce the EET, tax system in the country. Currently, the system for long term savings products like the PPF is exempt, exempt, exempt (EEE). This means that: The contribution is eligible for a deduction from income. The earnings in the form of interest is exempt from tax. The Final amount that is withdrawn is also exempt from tax.

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Thus there is no element of taxability in the entire process. As against this, the EET system will have the following features: The initial contribution will be allowed as a deduction or a tax benefit. The interest will be exempt from tax each year. There will be a tax at the time of withdrawal. Introduction of tax at the last stage can change the entire nature of the investment. The introduction of this can change the nature of the plan that an investor has because several things become an important factor for consideration. Some of the factors are: The amounts on which the tax has to be paid. Does it include just the earnings or also the initial capital? Tax Rate. Its applicability to various instruments. Alternative options available for investment. The employer might have a specific additional plan for the individual but the use of such a plan will add to the options present for the individual. The question for the individual should be on the type of plans that have to be adopted and how they can make the best use of the situation. Currently, the position in the country is such that: There is hardly a choice between defined benefit and defined contribution plans that requires great amounts of work to decide between them. This is because there are a limited number of different options in India. Further, a lot of the decisions are dictated by circumstances that the person finds himself in. Defined benefits will be the chosen option for most people because this has been used in most type of pension payments. However, the danger is whether they will continue to receive some payout under this option. This is because it is increasingly becoming difficult for employers to pay. Market conditions are also becoming so tough that it is difficult to maintain high payouts for a long period of time. There are other options like Insurance Plans and Mutual Fund Plans but these will be covered at a later stage in detail. Across the world, the companies are moving to a defined contribution system of payment where the risk is with the individual. The success and failures that various people in the US have witnessed with their 401(K) plans clearly shows that the going is not smooth for people even after they have put aside the sum for retirement. While choosing a particular plan, several factors are taken into consideration: How is the scheme operational? What are the benefits associated with the scheme? The kind of contribution that is required from the employee in such schemes. The amount of contribution by the employer in such plans. The earnings from such plans. The kind of capital accumulation that the individual will manage. If there are restrictions in the amount that can be invested in such schemes.

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Chapter Review

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