Articles

SIP may be the right way to build a long-term portfolio. But once you consider the fund management charges, pension plans will win hands down.

Following the furore over charges on unit linked pension plans, there is a general perception that mutual funds offer a superior alternative to unit linked pension products (ULPP). While this is true for a short-term investment, it is not necessarily the case in the long term. ULPP returns clearly overshadow MF returns by good a margin over a 20-year period. The whole idea behind ULPP is retirement planning. Under the plan, the investor sets aside a portion of regular income in a disciplined manner, which gets accumulated during his working years, to provide for retirement needs. It does not have death benefit attached to it and hence has no mortality charge. Payment can be made monthly, half-yearly or annually. The investor has to pay only the upfront charge and the fund management charge.

A systematic investment plan, or SIP (as it is more commonly known), on the other hand, is a way to invest in mutual funds regularly. The idea is to set apart a sum every month or quarter, and use that to buy units of a particular mutual fund, regardless of its price. Many investors prefer such a system because it helps them save regularly and build up an investment over a aperiod of time. The general view is that mutual fund is better than pension plan due to high upfront charges in ULPP. However, if a ULPP is available for 0.8% fund management charges, a 30% load will not hurt the investor.

THE ASSUMPTION

Let's compare LIC pension plan, Market Plus1, with an equity-diversified mutual fund to see which gives an investor the highest return in the long run. The investor is a healthy 35-year-old male and would like to retire in 20 years i.e. at the age of 55 The investor would like to invest 2,500 monthly ( 30,000 annually) for 25 years. In total he will invest 7.5 lakh for 20 years till he retires He has a high-risk appetite and would like to remain invested in equities throughout the tenure

THE RETURNS

UNDER PENSION PLAN

If the investor decides to buy a pension plan, then he will pay 30,000 annually. In the first year, the policy administration charge and premium allocation charge usually will be high. So, almost 20% of the premium goes in meeting these charges while the rest would be invested in 100% equity fund. Fund management charges (FMC) in the given ULPP is 0.80% per year. Administration charges is Rs 240 per year from the second year onwards and premium allocation charge is 2.5% per annum.

Assuming a compounded annual growth rate (CAGR) of 10% over a 20-year tenure, the investor's investments will grow to approximately 15,83,494. Total charges will come to 1,14,266. On maturity, the investor gets one-third of the corpus tax-free, while the rest is used to buy annuity. The income drawn from annuity is taxable under Section 80CCC. A major drawback of the pension plan is that if the policy is surrendered anytime within the policy tenure, then the fund value, net of surrender charges, is taxable.

UNDER SIP

Under an SIP, the investor will put in 2,500 monthly for 20 years in an equity diversified mutual fund scheme. However, unlike a one-time initial charge associated with the ULPP, mutual funds only have an exit load on their schemes. We have also assumed a decreasing FMC (fund management charges) on the mutual fund schemes - 2% for the first 5 years, 1.75% for the next 5 years and, thereafter, 1.5% for the remaining period. The declining FMC assumption is based on the fact that as the quantity for a mutual fund scheme grows over a period of time, economies of scale come into play. This helps the mutual fund spread its costs over a larger quantity thereby reducing its overall cost of managing the fund. Assuming a 10% rate of growth over a 20-year period, the mutual fund investments would have grown to approximately 14,87,868. Total charges will come to 1,97,646, which is almost 83,000 higher than ULPP. Since the earning on equity diversified scheme is considered as long-term capital gain it is tax-free.

THE CONCLUSION

The reason why LIC market plus scores over mutual funds is because of a low FMC.The FMC on the pension plan under review is 0.80% throughout the tenure as compared to the mutual fund FMC,which is in the range of 1.5-2%.Over the long term,FMC makes a significant impact by reducing the corpus available for investments.In other words,if someone is looking for an investment avenue for long term to provide for retirement needs,he could look at LIC Market Plus1 as a good opportunity. The fund closes on August 31.

Source: The Economic Times