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Types of pension plans and their tax benefits

14 December 2016
Before you purchase a Pension Plan, it’s essential you know how they work, as well as the tax benefits they offer.

After retirement, everyone needs a continuous flow of money to maintain their lifestyle. There are many private and public insurance companies that offer pension plans to take care of post-retirement expenses. These pension plans also offer various tax benefits. In this article, we will look at pension plans in detail.

What are pension plans?

Also known as Annuity Plans, these plans are designed to offer regular income to people after retirement. Pension plans allow the policyholder to choose the date (also known as the vesting date) from which they can start receiving the pension. This date need not be after retirement and can be much earlier.

Related: 5 Easy Steps That Make Retirement at 45 A Possibility

There are various types of pension plans offered by insurance companies. Let’s look at them in detail.

  1. Immediate Annuity:

In an Immediate Annuity plan, the individual has to make a one-time investment in lump sum and they receive a regular pay-out called ‘pension’ for the rest of their lives. In most cases, the pension can start with immediate effect. The frequency of the pay-out can be monthly, yearly, quarterly and semi-annually.

Immediate annuity plans are ideal for those who want to ensure they receive regular income even after they retire.  The biggest drawback of an immediate annuity is that you cannot withdraw the investment amount or cancel the annuity.

The returns on immediate annuity can vary. For example, you can choose to get a higher return up to certain years, say 10 years after retirement. Thereafter, you will still get an annuity, but at a lower rate.

Related: How Budget 2016 should affect your investment decisions

  1. Deferred Annuity:

A deferred annuity is a type of annuity contract that defers or delays payments of income until the investor chooses to receive them. In deferred annuity, there are two main phases- the Savings or Accumulation phase and the Income phase.

In the Accumulation Phase, the policy holder pays premium at regular intervals for a specific number of years.

At the end of this phase, the Income phase begins, wherein 1/3rd of the money accumulated can be withdrawn, while the remainder is used to buy an annuity product, which generates regular income for the rest of the policy holder’s life.

There are two types of Deferred Annuity plans:

        a. Traditional Retirement Plan:

In these plans, the investment is mostly made in debt instruments such as government securities. The low risk associated with such financial products makes these plans an attractive option for risk-averse investors. 

Related: Tax Benefits after Retirement

b. Unit-Linked Pension Plans:

These are designed for those who want to plan their retirement early. These plans offer a higher chance of returns than traditional retirement plans. Under unit-linked pension plans, investors can choose to allocate their investment in different asset classes, such as equities, debt, etc.

Tax Benefits of Pension Plans:

Pension plans provide certain tax benefits, depending on the type of plan chosen.

Section 80CCC: This section of the Income Tax act was introduced by the government to encourage people to invest in pensions. Under this section, any contributions towards pension funds can be deducted from the gross income, leading to tax savings. As of 2015, the maximum deduction allowed for investment in pension funds is Rs. 1.5 lacs per annum.

Tax benefits on Withdrawal: At the time of withdrawal, you can withdraw up to 1/3rd of your accumulated pension funds without paying any tax.

Related: Things you didn't know about tax savings [Infographic]

When planning for retirement, the most important step is to start early. To provide you with a guide on planning for retirement based on what stage of life you are in, check out Life stages and Investment [Infographic].


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