What is a pension plan?

When you talk about various fund allocation options for retirement planning the most common option that will be suggested to you is pension funds. If you do not know what is pension plan and how do they work this article will help you to solve all your queries related to it. Pension plan is basically a retirement plan in which an employer has to make regular contribution to a pool of funds that will be paid back to the worker in his retirement years. In simple words the funds are invested on behalf of the employer and the earnings on the investments are paid to the worker

Adding to the funds contributed by the employer towards the pension plan some plans also allow the option of voluntary investment. In such, a plan, even the worker himself can invest part of his current income from salary into the pension plan to create sufficient retirement corpus.In India, the pension plans are usually offered by the life insurance companies as bundled products. This provides both future investment as well as insurance.

How does a pension plan work?

There are two major phases in any pension plan you choose these are accumulation phase and annuity phase.

Accumulation phase – In this phase, one has to invest premium amount throughout the tenure of the plan. The fund collected from the premiums is invested in securities by the insurance company, which grows the money and accumulates wealth. This wealth is then paid back as regular income after the retirement of the worker or when the policy is matured.

Annuity phase –During this phase, the investor starts receiving the invested amount as a regular payment that is pension. In the investing period that is 50 to 70 years of age, one can withdraw 33% of the accumulated funds. The remaining can be utilised to buy an annuity plan that will lead to pension based on type and mode you select.

Where do pension plans invest?

The pension plans offered by insurance companies in India broadly fall under two categories. One is endowment plans that will invest the funds only in debt instruments like government bonds, government securities, etc. Safety is the crucial factor and thus the returns are in single digit only.

The second category is Unlit Linked i (ULPPs). ULPPs has gained popularity since the private companies have been granted permission to enter insurance sector. In ULPPs you get a benefit of choosing where you want your money to be invested be it 100% equity, 100% debt or the hybrid of both the plans. You can evaluate your risk appetite and select accordingly. In ULPPs you also enjoy the option of switching from one fund profile to another in case you are not satisfied with the option you chose earlier. For instance, you may invest in equity but later realise that debt fund profile can give you better returns, then you can switch your funds easily.