Feb 24, 2009

Mutual Funds Pension Plans - Section 80C Another Debt Option

Though ELSS is the best section 80C option but if you’re hesitant to invest in it as the risk factor is evidently higher and doesn’t match your risk profile; there is yet another mutual fund option to invest in and also save tax under section 80C.

Yes, I’m talking about mutual fund pension plans (or funds), which are debt-oriented tax saving funds and most neglected investment option – due to lack of awareness – among all the various tax saving instruments under section 80C such as PPF, ULIPs, SCSS, NSC, ELSS, Bank’s 5 year FDs and life Insurance. Please don’t confuse them with pension plans of insurance companies.

Although branded as pension plans, these are simple debt oriented mutual fund laced with tax benefit under section 80. Unlike pension plans of life insurance companies, these plans don’t offer you any pension or annuity. As these schemes are meant to encourage you to save and invest long term for your retirement, they mandate that you stay invested till the age of 58.

At present, there are only two such funds available – UTI Retirement Benefit Pension Fund (UTI-RBPF / UTI-RBP) and Templeton India Pension Plan (TIPP).

Comparison with ELSS and PPF

Position vis-à-vis ELSS

1. Risk Factor: Unlike ELSS funds which invest 100% in equities, pension funds have the mandate to invest not more than 40% in equities. Thus, risk level of mutual fund pension plans is lesser as compared to ELSS funds.

2. Liquidity: Both ELSS and mutual funds pension plans have lock-in period of 3 years. But, unlike ELSS schemes, mutual fund pension plans – as the name suggests – are meant only for long term; therefore, these funds impose stiffer penalties for premature withdrawals even after mandatory lock-in period of 3 years is over. Thus, pension funds score poorly on liquidity factor.

3. Returns: The current 5-year returns of these funds are around 8 per cent whereas ELSS category has delivered in excess of 10 per cent. Over a longer period of, say, 15-20 years ELSS (being equity funds) deliver even more better returns than mutual fund pension plans (which are debt-oriented balanced funds).

4. Taxation of maturity proceeds: Unlike ELSS funds, where the entire proceeds received after 3 year lock in period are exempt, the mutual funds pension plans tax treatment is similar to those of debt oriented mutual funds.

Position vis-à-vis PPF

1. Risk Factor: First, while PPF is a pure debt product, mutual fund pension plans also contain some equity usually in the range of 20% to 40%. Second, while PPF offers assured return (but not fixed), the debt portion of mutual fund pension plans carries interest rate risk and credit risk. Thus, we can say that though risk is lower than ELSS but slightly higher than PPF.

2. Liquidity: Though both PPF and mutual fund pension plans score poorly on liquidity, PPF is a lot better than Pension plans in terms of making premature withdrawals. The maturity period of PPF is also less as compared to mutual fund pension plans.

3. Returns: Though the current five year returns are almost at par with PPF, mutual fund pension plans have the potential to deliver better or superior returns than traditional tax-saving instruments like PPF due to two reasons: First, as mentioned above there is some exposure to equity and second, even the debt portion is invested is market linked instruments which have the potential to give higher returns depending on the interest rate scenario.

4. Taxation of maturity proceeds: While you earn tax-free returns from PPF, mutual fund pension plans returns are taxable.

Well, mutual fund pension plans are a good option to invest. But the primary reason to invest in them should never be section 80C deduction. You should consider opting for them based on the following conditions:

a) You can spare funds for long term. As obvious, from the name itself, these are meant only for long term investment. There are exit loads to discourage investors from making early redemptions. For instance, in case of TIPP, even after the mandatory 3 year lock-in, there is a stiff penalty (i.e., exit load) of 3% before maturity and the scheme matures on your attaining 58 years of age. Thus, you should consider investing in these funds only if you can spare the funds for long term because existing prematurely is a costly proposition.

b) You’re really serious about long term financial planning and want to make provision for your retirement.

c) It should form part of your overall asset allocation. Put simply, otherwise also you would like to invest in a debt-oriented or balanced mutual fund as part of your asset allocation strategy. Here, you should consider the tax benefit under section 80C as a kind of bonus which you won’t be allowed in other debt oriented mutual funds. However, remember than tax treatment of maturity proceeds is similar in both mutual fund pension plans and plain vanilla debt oriented mutual funds.

Finally, before investing you should analyse the actual performance of these funds. As mentioned above, right now there are only two such funds available in the market namely Templeton India Pension Plan (TIPP) and UTI Retirement Benefit Plan (UTI-RBP). As per Value Research (as on February 20, 2009) while 5 year returns of TIPP are 7.81%, UTI-RBP has delivered CAGR of 8.49 per cent during the last 5 years. And, while rating of TIPP is 3 stars, UTI-RBP has been given a lower rating of two stars by Value Research.

As you must be aware that it’s always preferable to invest in 5 star or 4 star rated funds, so avoid them. If you want to invest in debt oriented or hybrid mutual funds, you can find many better performing funds. As far as tax savings under section 80C are concerned, there are many other better options to invest. For a comprehensive list, please read “Section 80C Tax Saving Options & Investment Avenues”.

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