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Pension Funds In India – Meaning, Overview, How Do Pension Funds Work, Types, Pension Plan Features and Tax Benefits

Pension plan is an investment cum insurance product where you invest a specific amount throughout your working life. Here are five things you should know about the working of pension plans.

  • Dec 15, 2021

​Rising life expectancy and inflation have made it necessary for every working professional to start planning their retirement as early as possible. A pension plan is a product exclusively created to provide a regular stream of income after retirement. 

With features like life cover, investment, and steady returns, a pension plan could be an ideal choice for every individual concerned about retirement planning. . But before you start researching and comparing top pension plans in India, it’d be wise first to understand how they work.

Here are 5 things you should know about the working of pension plans

1. What is a Pension Plan?

As the name suggests, a pension plan is an investment cum insurance product where you invest a specific amount throughout your working life. Once you retire, the insurer will then start providing regular payouts as per the terms and conditions of the plan. 

These plans generally come with guaranteed maturity benefit and death benefit. Some of the insurers also offer add-ons or riders. , such as accidental death and permanent disability benefit. 

2.What are Accumulation and Distribution Phases of a Pension Plan?

Every type of pension plan has two stages- accumulation and distribution. The period you pay premiums to the insurer for the selected term is known as the accumulation phase. These funds are invested in the assets you choose.  

Once you retire, you have the option to ask the insurer to start paying you a regular pension or annuity. You can also withdraw 1/3rd of the accumulated amount on retirement and use the rest for purchasing an annuity from the same insurer. This phase is known as the distribution phase. 

3.What is the Vesting Age in Pension Plans?

Another term you should know about before purchasing a pension plan is the vesting age. The vesting age is the age after which you’d like to start receiving an annuity. You can choose from monthly, quarterly, half-yearly, and yearly pension payouts. 

With most insurers, the vesting age is generally 45-50 years. But you do get the option to choose a vesting period of up to 70 years in most cases. It can be higher than 70 years with some insurers. 

4.How are Pension Plans Taxed in India?

With pension plans, you can choose between an immediate annuity and deferred annuity. For instance, if you are already close to your retirement age, you can select an immediate annuity. In these plans, you invest a lump sum amount and start receiving a pension immediately after investing. Here the principal amount is tax-exempt, and the interest is taxed like any ordinary income. 

With a deferred annuity plan, you start making small contributions towards the plan through premium payments (accumulation phase). During this period, the investment grows without any tax deductions. 

5.Can You Surrender or Discontinue a Pension Plan?

Yes, you do have the option to surrender or discontinue a pension plan whenever you like. In the past, people were only allowed to terminate a pension plan after five years from the date of purchase. But this restriction has now been removed. 

  • Surrender within five years

If you surrender a pension plan within five years, the fund’s value on the surrender date will be moved to a discontinuation plan after deduction of some charges. 

Even this discontinued plan will earn interest at 4% p.a. You can withdraw the funds after five years. However, the proceeds from policy surrender can only be used for purchasing an immediate or deferred annuity plan.  

  • Surrender after five years

If you want to surrender the plan after five years, there will be no discontinuation charges, but the proceeds can only be used for purchasing an immediate or deferred annuity. 

Building a Stable Retirement Income with a Pension Plan

While your monthly salary will stop after retirement, expenses will continue to exist. Therefore, a pension plan is an excellent way to receive regular income and be financially independent even after retirement. 

Kotak Life Time Income Plan

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Ref. No. KLI/23-24/E-BB/1052


- A Consumer Education Initiative series by Kotak Life

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