How Pension Plan Works?
Retirement/Pension plans offered in India by life insurance companies are bundled products, which offer the benefits of both insurance and investment. A typical pension plan has two phases –
Accumulation Phase
In accumulation phase, you pay premiums and the money accumulates through the tenure of the plan. The premium payments made are collected and invested in securities approved by the IRDA, so that at the time of the policyholder’s retirement, enough money has been accumulated (as retirement corpus) to earn a regular income.
Annuity Phase
The accumulation stage is followed by the vesting age (the vesting age in most plans is 50 to 70 years), which is the age when you start getting payouts from the above accumulated money (retirement corpus). The period when a person gets pension is also called the annuity phase. During this phase, you can withdraw up to 33% of the accumulated amount in one go. The rest is paid as pension in montly/quarterly/half-yearly or annual basis mode, as selected by you.
Types of Pension Plans
Pension Plans are broadly two types –
A- Personal Pension
B- Work-based Pension
A- What is a Personal Pension Plan?
This is a pension policy that’s taken out through a pension/life insurance company, into which you pay contributions and will at retirement provide some or all of your pension income. These are invested in funds, which you can choose according to your attitude to risk and plans for the future. In personal pension, there is no involvement of employer. A personal pension is set up on a defined contribution basis.
Types of Personal Pension Plan
Personal Pension plans are two types –
1- Deferred Annuity Plan
2- Immediate Annuity Plan
1- Deferred Annuity Plan
In case of deferred annuity, the annuity is ‘deferred’ up to a time, which is decided upon by the policyholder. For example, if an individual buys a pension plan with tenure of 30 years (also known as the ‘deferment period’), then his annuity will begin after 30 years. Deferred annuity premiums can be paid as a ‘single premium’ or as ‘regular premium’.
2- Immediate Annuity Plan
In the immediate annuity option, the annuity does commence immediately. The policyholder has to pay in lump-sum and the annuity/pension commences immediately or within one year of having paid the premium. The frequency of payments received can be monthly, quarterly, half-yearly or annually.
B- What is a Work-based Pension Plan?
A work-based pension scheme is set up by an employer to provide a way for employees to save for their retirement. Both the employer and the employee may contribute to the scheme. The employee’s contributions are usually collected directly from their salary or wages.
Types of Work-based Pension Plan
There are three main types of work-based pension plan:
1- Defined Benefit (also known as DB, Final Salary or Salary-related) – benefits are calculated based on how much a member earns and how long they are an employed member of the pension plan.
2- Defined Contribution (also known as DC or Money Purchase) – benefits are based on how much the member and employer pay into the plan, and also on the performance of the investments made with that money. The income the member gets at retirement will depend on the amount of money in their fund, the age at which they retire and also the cost of buying a pension (the annuity rate) at the time.
3- Hybrid – a mixture of DB and DC.
The above illustrations are courtesy simplifiedfm.com.