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What is a Pension Plan and How it Works?

It has been an age-long practice to plan for one’s retirements and save funds for the same. That is because when you finally retire, you want to relax and enjoy life; you don’t want to be burdened with financial obligations, which disturb the years of peace. Now, there are several ways you may go to save and plan for your retirement. That said, one of the most common ways to do so is through a pension plan. In this blog, we will learn what pension plans are and how they work in India so that you have a better understanding of how they can contribute to your retirement plan and savings. 

What is a Pension Plan?

A pension plan is a retirement savings tool that helps you accumulate funds for your retirement years. These pension plans allow you to contribute a portion of your income towards retirement sayings. The party managing the fund will then invest your contributions into various financial assets like stocks, bonds, and government securities. By contributing a portion of your income to the pension fund, your money will eventually compound over time as the value of the financial assets appreciates over time. 

How Does a Pension Plan Work?

Let’s now understand the mechanism of pension plans.

Accumulation and vesting phases: In India, pension plans have two phases, namely—accumulation and vesting phases. The accumulation phase is the period in which you regularly invest and add money to the pension fund. As mentioned in the previous paragraph the pension funds invest your money in financial instruments like stocks, bonds, mutual funds, etc, this accumulation spans for a predetermined period. 

On the other hand, the vesting phase or distribution phase starts when you retire and start receiving the benefits of your pension fund to help you take care of various expenses in your golden retirement years. When the distribution phase starts, you have two choices. You can either opt for a regular income similar to pension, and this distribution will last for several years after you retire. Or else you can even choose to withdraw the proceeds of the fund in lump sum. 

Maturity benefits: In India, all pension funds provide guaranteed maturity benefits; in other words, they provide a fixed income, which makes them fixed income investments. Hence, that makes pension funds safe investments, which is why they are also called as guaranteed pension plans. Typically, the maturity benefits are 101% of the premium paid, which is more than double of the year cumulative investment; whichever is higher. 

Pension plans may also have a guaranteed death benefit, if the premiums are paid regularly without any breaks and pauses, The death benefit should equal to 105% of the total premiums paid. This benefit can be quite useful if a pension plan holder has an untimely death, as their beneficiary/nominee. In the event the pension fund is discontinued due to the untimely deaths, the amounts accumulated are given to the nominee. The nominee can either withdraw the entire death benefit, or buy an annuity plan with the entire proceeds. They could even withdraw a portion of the proceeds and use the balance to purchase an annuity plan. 

How to plan your retirement fund? 

When you are buying a pension plan for retirement, it is essential that you think of your retirement goals. For example, you may want to settle in your native place when you retire. So, determine how much money you will require for your retirement plans. You also think about what you plan on doing after you retire. Some people may just want to live comfortably, while some may want to practise their hobbies, like music, cooking, etc. Some may go even further and try to start a small-side business, like a tiffin delivery service. Depending on your goals, you decide the maturity type and seek a maturity value you would like to get from your pension plan. 

Conclusion

Pension plans are a useful tool for retirement savings, but they can be complex and are subject to various regulations. It’s important to carefully review and understand the terms and features of any pension plan you may be considering. It is important that you understand their advantages and disadvantages. To learn more about pension plans, you can always consult a financial advisor. Firms like Aditya Birla Sun Life Insurance expertise in such matters. That said, pension plans do come in handy in your golden years, as they provide a steady stream of income during retirement. With a defined benefit plan, the retiree knows exactly how much income they will receive each month, which can help with budgeting and financial planning.

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