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How Do Pension Plans Work? - Details and Features

March 07, 2017
Taking up a pension plan is one of the easiest ways to secure the golden years of life. However, before buying a pension plan, it is important to be acquainted with its working and features.

What is a Pension Plan?

A pension plan is a financial tool that enables you to accumulate funds for your golden years. You must invest money into your pension fund at regular intervals. By doing this, you will build up a significant corpus. Generally speaking, pension plans have two phases – the accumulation phase and the vesting stage.
  • Accumulation Phase
    The period during which you regularly invest money into a pension fund is called the accumulation phase.

  • Vesting Phase
    Once you retire and start receiving a steady flow of income from your pension plan, you have entered the vesting phase.

    How Do Pension Plans Work?

     Pension plans in India are structured into two parts i.e. accumulation and distribution. The premium paid towards a pension plan is invested in a fund/asset of your choice for a pre-determined period. After the plan attains maturity, you will start receiving the pension benefits, which is also known as vesting. At the time of vesting, you will have two choices. You can either start receiving the pension benefits or withdraw the proceeds and purchase an immediate annuity plan from the same company.

    Here are some of the compulsory features of pension plans in India:-

  • Guaranteed Maturity Benefit
    All pension plans in India provide guaranteed maturity benefit. This is the reason why pension plans in India are also known as guaranteed pension plans. The maturity benefits are generally the fund value or 101% of Premium paid, whichever is higher. Guaranteed pension plans are a safe and lucrative investment that will provide value for your hard-earned money.
  • Guaranteed Death Benefit
    If the premiums are paid regularly without any breaks in between, a pension plan will carry a death benefit. The death benefit will be equal to 105% of the total premiums paid including all the top-ups if any. This amount will be paid out to the beneficiary/nominee in the event of the untimely death of the policyholder. However, if the pension fund is discontinued due to some reason, the funds already accumulated in the policy will be given to the beneficiary.

A Nominee Can Utilize Pension Funds in Three Ways

A nominee has three choices to utilize the pension funds:-

  1. Withdraw the entire death benefit
  2. Buy an immediate annuity plan with the entire proceeds
  3. Partially withdraw the proceeds and use the balance amount to buy an annuity plan.


Earlier, your pension plan would be forfeited if you don't pay the premium regularly for at least 3-5 years. However, the rules have changed at present. Now you can choose to surrender or discontinue your pension plan whenever you want to. However, if you discontinue the plan, a specified charge will be deducted from the fund value. A discontinued fund will also continue to earn 4% p.a. and you can withdraw the accumulated funds after 5 years. On the other hand, if you surrender a pension plan within 5 years, the proceeds have to be utilized to buy an annuity plan (immediate or deferred).

Selecting the Right Pension Plan

When it comes to saving and investing for the future, there is no formula. You must pick a pension plan based on how much you can afford to save up or invest every month. Your risk appetite and retirement goals will also play a role here. You must come up with a sound plan based on how much money you will likely need in the future to cover your daily expenses, potential healthcare costs and all your retirement goals.

Features of Pension Plans

While choosing a pension plan, you should look for:

  • Guaranteed Benefits
    Once you retire, you would need a steady income to help you take care of your monthly expenses. Your pension plan should provide you with financial independence even after you retire. Look for plans that offer guaranteed benefits.
  • Tax Benefits
    The contributions you make to your pension plan will likely be exempt from taxes under Section 80C of the Income Tax Act, 19611. Depending on the kind of pension plan you opt for, the returns you receive might also be tax-free.
  • Can Be Customised
    When you opt for a pension plan, you have the power to choose your accumulation years, your vesting age and the payment period. So if you get a pension plan when you are 30 and your accumulation period is 30 years, you will invest money until you turn 60. You can pick your vesting age to be 65, which is the age when you’d like to retire. If you want the payment period to be 15 years, you will receive a steady income until you are 80.
  • Flexible Payouts
    Most pension funds allow you to pick how you’d like to receive the benefit. You can decide whether you want to receive monthly or annual payments.
  • Life Coverage
    Possibly the most crucial benefit of a pension plan is that it also provides life insurance cover. The sum assured amount will allow your dependents, like your spouse and children, to remain financially independent.
  • Tips for Buying Pension Plans
    Once you understand how pension plans work, you can purchase one to secure your financial future. Here’s a look at what you need to do to identify the best pension plan for your needs:
  • Understand Your Finances
    Before you start planning for the future, you need to understand your current finances. How much do you currently earn and what can you afford to invest? How much money do you need per month and what will you likely need in 10 or 20 years to retire comfortably? By answering these questions, you will get a better understanding of how much you will need to invest and how much you will need once you retire.
  • List Your Retirement Goals
    What would you like to achieve once you hang up your work boots? Some people choose to pick up a hobby; others hope to travel, while some people are content spending time at home. Some retirement goals, such as travel, require significant funds. Your goals will help you understand how much money you may need in the future.
  • Have a Back-up Plan
    You should never put all your eggs in one basket. Banking on only one investment or one pension plan will not be enough. You must have a few investments going to help you deal with a potential shortfall or financial emergency.
  • Ask an Expert
    If you’re still not sure about what you should do, you can always ask for help. Consult a financial expert regarding your retirement goals. They will help guide you towards the best plans available for you.

ARN – ED/01/22/27346


Plan Your Retirement Now

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1.as per Income Tax Act, 1961. Tax benefits are subject to changes in tax laws.