Pensions

Video: Pension Plans vs. Do It Yourself

11 comments Written on June 13th, 2010 by
Categories: Pensions, Video

My latest Deepak Shenoy Talks Video on the Max New York Life Insurance Plan I was sent recently. Thought I’d do a video format and demonstrate exactly how much you lose when you go with a pension plan, compared with doing it yourself.

 

In this plan comparison, just investing in a Nifty ETF and getting 1/10th lower returns than thei pension plan’s advertised 10% gives you a 37% higher “pension” than the pension plan.

Outperformance by sitting around and working three formulas on an excel sheet. In fact, if you take real world investments, you would outperform by about 70%.

What I didn’t mention: the flexibility of doing it yourself is that you can also increase investments when you have money, and stop it when you need money.

Update: P V Subramanyam on Subramoney said I missed out on something important. And guess what: He found out: What happens if the person dies after 5 years of retiring? The remaining money goes to Max New York Life! Meaning – they offer this as a pension for life WITHOUT return of principal, which makes the plan EVEN more bad, in comparison with the g-sec investment. (where, if you die, your next-of-kin inherits the bonds, the cash flow and can do what they want with it).

Links:

Posted in Pensions, Video

IRDA Makes Insurance a Must For Pension

6 comments Written on June 1st, 2010 by
Categories: Pensions

In the process of the SEBI fight, IRDA has decided it will kill the concept of pension products as pure retirement plans. In it’s recent order:

Based upon the insurance related data as of year ending March 31, 2010 and related
discussions, the Authority issues the following clarifications in continuation of the ULIP
guidelines “Guidelines on Unit Linked Products” issued vide Circular No.
032/IRDA/Actl/Dec-2005 dated 21.12.2005:


A. The following provisions of the said Guidelines are reiterated:
1. Minimum policy term: The minimum policy term shall be five years in the case of
individual products and group products shall continue to be on annually renewable basis.

2. Guarantees on policy benefits: All linked products including pension / annuity products must have a minimum sum assured payable on death, as per the Circular mentioned under Para 7.3 below. In case of unit linked products providing health insurance cover, the provision of death benefit is not mandatory.

3. Loans: No loan shall be granted under Unit Linked Insurance Products.

B. In further clarification on partial withdrawals, the paras 7.3, 8.1, 8.2 and 8.3 of the said ULIP guidelines of December 2005, shall be substituted /modified.

7.3 All top-up premiums made during the currency of contracts must have insurance cover, treating it as single premium, as per Circular No: 061/IRDA/Actl/March 2008 dated March 12, 2008.

8.1 Partial withdrawal is allowed only after fifth policy anniversary for all unit linked products except pension / annuity products. In the case of unit linked pension / annuity products, no partial withdrawal shall be allowed and the insurer shall convert the accumulated fund value into an annuity at maturity. However the insured will have the option to commute up to a maximum of one-third of the accumulated value as lump sum at the time of maturity. . In the case of surrender, only up to a maximum of one-third of the surrender value could be availed in lump sum and the remaining amount must be used to purchase an
annuity.

8.2 The last sentence “the provisions in this para shall not apply in respect of pension / annuity business” stands deleted.

8.3 Every top up premium shall have a lock in period of three years from the date of payment of that top up premium. However, top ups are not allowed during the last three years of the contract.

All other terms and conditions of the above said Circular and clarifications will continue in force.
The above modifications will come into effect from 1st July 2010.

All life insurers are advised that only the Unit Linked Insurance Products which conform to these revised guidelines shall be permitted to be offered for sale from 1st July 2010.

(Emphasis mine)

Why should pension products have insurance? Insurance is risk protection if you die. Pensions are risk protections if you survive. Very different concepts. But the reason is simple – SEBI and IRDA are defining their regulatory turf. If there is no insurance, SEBI will demand the right to regulate the product, which IRDA doesn’t want.

Another big pain is that pension products will not be easily surrender-able. If you desperately need money, you can only get 1/3rd of your fund value, the remaining is set into an annuity. Heck, that happens even when you retire and you want the money. But in the light of India’s horrible annuity products, this is very anti-investor. You save, and then you can’t even get decent returns on those savings, because you have to buy the crappy annuities.

Even top-ups will need insurance, and are locked in for three years. Four years ago, I used the top-up loophole successfully to avoid high commissions on a pension product I had bought – the premium charges were 10%, but top up charges were just 2%, so most of my money came through a top-up. This will no longer be feasible because of the insurance requirement (my policy has no insurance part).

This basically means there will be MORE mis-selling on pension products. With an insurance edge, a pension product becomes INFERIOR to a Ulip, because of the draconian exit rules. It is therefore better to buy a Ulip than a stupid pension policy from July 1 – in the sense that it is better to get punched in the face compared to getting shot.

If you prefer not to get hit at all, you should simply buy a decent mutual fund or an ETF and sit with it till your retirement. No annuity crap, and if you work with products that pay out dividend, you could have a chunk of money that gives a great yield, and has ample liquidity in case you ever need sudden money.

I am exiting my pension policy today. It’s not a heck of a lot of money but I needed to exit anyway before the DTC took effect and taxed the money, and it’s done a fantastic 10% in four years, a magnificent return of less-than-inflation 2.9% a year annualized. What I bought it for was to reduce wage taxes, mission accomplished, so time to move on.

Posted in Pensions

Low Annuity Returns in India

19 comments Written on January 16th, 2010 by
Categories: Insurance, Pensions

Why are annuity rates in India so crappy?

(Annuity: Pay a lumpsum now and receive a fixed income for the rest of your life)

image

This is the return for a 50-lakh rupee annuity, purchased at age 60.

LIC provides an annuity that returns your entire purchase price ('principal’) to your next-of-kin when you die. This – as you can see above – provides a return of 7.50% or so per year. And the income is taxable.

Let’s look instead at buying a 25 year government bond – the principal is protected and returned at the end. The bonds are available for a yield of about 8.30% – which means for a 50 Lakh purchase, you can get back 4.15 lakhs per year (again, taxed).

All LIC has to do is buy 25 year maturity government securities and rake in the Rs. 40,000 per year extra that they make. That’s equivalent to paying 11% commissions, every single year!

A counter argument is that LIC is getting paid “managing” the money. Bollocks. This is ONE BLOODY TRADE, that’s it. What if the person lives to beyond the 25 year term, you ask? (Since LIC has to field that risk) First, average Indians do not live up to 85 years old (which is when the product matures) and last, the rollover trade to higher maturities is very possible without a loss. And 11% to do this? Excuse my sputtering, but this is frikking ridiculous.

[Annuities are important if you are considering the New Pension Scheme (NPS). At retirement (60) you will need to buy an annuity with 40% of the corpus. ]

Good business if you can get it, though. But in the face of competition have private insurers not tightened things up?

Most other insurance companies don’t offer this kind of “return of principal” – they just take your money and give you a pension till you die. When you die (and in some cases, when both you and your spouse die) the money flies to the big hole in the sky. Rates of return for such annuities vary from 5.8%  to 9.7% per year; the maximum I could see for a 60 year old was about 4.87 lakhs per year at LIC. (50 lakh purchase). Some private insurers offer just 5% returns, so forget the “competition” business.

How does this work? They could buy Government bonds and for the excess return (above 8.30%) redeem a part of the investment and pay the annuity. The average Indian is expected to live till around 65 years of age. Even if you consider an average lifespan of 75 , the “redeem the excess” strategy will leave Rs. 30 lakhs as the insurer’s profit when the pensioner dies.

(This is assuming the insurer just buys government bonds, just so you can understand how profitable the business is. You can get this kind of return yourself, with very little effort. Insurers have better options and much higher return capabilities beyond the above mentioned bits.)

Like I said, good business if you can get it. It’s time we got a financial player that really squeezed the margins and provided good products. If we get rid of overheads – excessive commissions and other bull – paying less than 1% a year as intermediation costs will become a reality. Financial products are usually sold, not bought; but it doesn’t mean that will not change (“Selling” means commissions, means higher cost and all that). It is truly unfortunate that doing this business requires so much money upfront – becoming an insurer, for instance, needs a net worth of Rs. 100 cr.  - or I would be doing it. It’s an option I have explored, is on the radar and currently out of my reach financially. But I’m biding my time.

Posted in Insurance, Pensions

FDs or government bonds better than "Insurance" plans

12 comments Written on September 10th, 2009 by
Categories: Pensions
A twitter discussion led Ganesh Babu into writing about how insurers take you for a ride. An ad at www.simpleinsurance.in from ICICI shows you how, if you invest Rs. 2,000 per month for 20 years, you could get a pension of 15,315 per month after 30 years (at 10% annualized return).
But let's have a closer look. Let us put the Rs.2,000 per month in a bank fixed deposit (FD) at a nominal 8% interest compounded annually. That makes Rs.24,000 annual investment in FD. For the next 30 years, let us assume that the interest rate remains constant at 8%. The Rs.24,000 per annum investment at 8% will accumulate to Rs.29.36 lakhs.

This amount (Rs.29.36 lakhs) if reinvested again in FD at 8% interest will give annual interest of Rs.2.35 lakhs or a monthly interest of Rs.19,575 for life. Now compare with this the Rs.15,315 per month ICICI's Retirement Plan. The FD comprehensively beats the returns of ICICI by a massive Rs.4,260 per month (21.8% more). And don't forget that the FD return is more or less guaranteed where as ICICI's 10% return in risky and market dependent (it could be less, or more). Also, the accumulated Rs.29.36 lakhs is preserved for passing on to the next generation

If you went with ICICI - you would pay 2,000 a month, maybe get your 10% return, and in return get a pension of Rs. 15,315 per month. After you die, they give the money to your spouse. And from first takes it seems after your spouse dies, the corpus is involuntarily donated to ICICI. (Want the money back? Er, we'll pay you around 1.5K less per month, ok?)

If you consider the same 10% return, then the amount you make, annually compounded after 30 years, is 39.47 lakhs. (Ganesh has wisely taken a more sane fixed return of 8%, but I'm illustrating how much you're being robbed). That, invested in an FD or govt. bond at 8% yield, gives you an income of 26,319 a month. Glee. 40% more than the "insurance" option. Not just that, your family gets to see the entire money should you die.

And there's the flexibility - need some extra money for hospitalization, to start a business or anything of that sort? With ICICI's annuity, you have no options to withdraw a big lumpsum. In option 2 - where you manage your own money - you can do what you want.

ICICI's retirement plan - and to be fair, every single insurer's retirement plan - is a waste of time. Simply buy long term FDs, long term government bonds or growth gilt funds; the return is far superior. If you want tax savings, get into a term plan and buy an ELSS mutual fund; anyway they will not last much longer (the tax saving nature of them).

Ganesh's post is eye opening and I will do a post on the crappy annuity plans we have, on another day. That alone is enough to never ever recommend the New Pension Scheme to anyone I know; because it's your money they don't allow you to touch.

Posted in Pensions

NPS (New Pension Scheme) has "hidden" charges

No Comments » Written on May 27th, 2009 by
Categories: NPS, Pensions
Sanjay Bhargava points me to this livemint article:
India’s New Pension System (NPS) promises the lowest fund management charges. But a closer look at the fine print brings out hidden costs.

The cost to the investor is high unless monthly investment is above Rs3,000 An investor depositing Rs500 per month, or Rs6,000 a year, will have to cough up as much as Rs800, or 13%, as charges in the first year. There is a one-time charge of Rs50 to the central record keeping agency and Rs40 to the point of presence, while Rs350 must be paid as annual maintenance charge. An investor also has to pay Rs30 every time one makes a deposit, switches a fund manager or even seeks a statement. Charges of demat, receipt of shares and charges by markets regulator Securities and Exchange Board of India are additional. Fund management charges are added to that.

"The cost to the investor is significantly higher unless he is investing Rs3,000 per month, as NPS is designed today," said U.K. Sinha, chairman and managing director, UTI Mutual Fund.

The attractiveness of NPS was the lower charges. Otherwise, compared to a mutual fund (much lower tax at 20%) or insurance (zero exit tax), it would have been non-competitive. But I have to do a more deeper post - time is a problem nowadays - to demonstrate the real cost and return expectations of the NPS. (Last year, though, they did very well, with nearly 15% returns, due to the big investment in govt. and corp debt)

Posted in NPS, Pensions

PFRDA Opens the New Pension Scheme (NPS) to all citizens

6 comments Written on May 3rd, 2009 by
Categories: NPS, Pensions
PFRDA - a horrendously complex acronym for a pension fund regulator has opened up the New Pension Scheme (NPS) to all citizens. Read the Offer Document, Welcome Kit, Subscriber Registration Form and Investment Guidelines.

Note: I've written about PFRDA earlier as part of my Make Rating Agencies Irrelevant theme, and I'm happy to note a certain part of my thoughts have been addressed: now, the section for investment in credit instruments asks for only 75% of the investment to be done in "investment grade" corporate bonds - the rest is left to the investment managers discretion. This is slightly better, and given investment grade rated stuff is on the same line as (unrated) liquid funds, fixed deposits and PSU/PFI/Muni/Infra bonds, it should help in making rating agencies irrelevant.

Let me go through the fundas of the New Pension Scheme (NPS) in some detail.

  • First a small primer. Government employees must contribute to the NPS, and the government will match their contributions. It's only since May 1 that all other citizens can register with the NPS.
  • Any citizen can register. NRIs need a local bank account, and need to be KYC compliant. There are a lot of NRI regulations - present in detail in the offer documents. (I know that some of you are NRIs, and perhaps want some clarity on this, maybe I can do another post on the NRI applicability of this in another post.)
  • Mandatory payments: 500 per contribution, 6000 per year. And you have to transact four times a year, minimum. If you don't meet the minimums, you have to pay Rs. 100 per year of default, and make up all minimum amounts. Your account gets marked "dormant" till then.
  • Two kinds of accounts - Non-withdrawable (Tier-I), and savings (Tier II). Right now, there's only Tier I.
  • Fees: There's about Rs. 100 for registration (350 to one entity and 40 to another). Apart from that, there's a Rs. 30 per transaction that you'll pay. Annual fees are 350 a year. The fund mgmt charges are very low - add up to about 0.009% or so.
  • Investment control: You can choose any of the six shortlisted fund managers to manage your money.
  • Your money can be invested in Equity (E), Credit (C) or Government (G) instruments, and you can decide the ratio of these instruments in your portfolio.

    Equity is linked to the Nifty/Sensex. Government is G-Secs, or Gilts. Credit involves liquid funds, fixed deposits, PSU bonds, Infrastructure or municipal bonds and corporate bonds.

    You can't put more than 50% into Equity. If you don't want to choose the ratio, there's an "auto choice" option that chooses between the three options depending on your age.

  • Once you select you can't change the fund manager or your investment ratio till May 2010. For Now.
  • Withdrawals: If you withdraw before you're 60, you have to invest 80% of your money in an annuity and take the remaining as a lumpsum. At 60, you have to put at least 40% into an annuity, and take the rest out (you can phase the rest till you're 70). And if you die, the whole amount will be given to the nominee as a lumpsum.
  • Taxation: All pension fund investment is tax-free, uptil 100K per year, under section 80c. Don't rejoice, because this 100K includes all other 80C instruments (like Housing loan principal, Employee PF, Life Insurance, Children's education fees etc.)
  • Withdrawals are currently fully taxed. PFRDA is trying to get withdrawals tax free too, but it's not quite worked yet.
  • You will get an IPIN and a TPIN to get your account status online or on the telephone. The site online is: http://npscra.nsdl.co.in
So is this NPS a good deal? That's a very good question. First, we don't know yet how it will pan out - will an investment manager be better than another? Will you really be able to change things at will? Will the taxes screw you out of your own money?

Another post coming up...

Posted in NPS, Pensions