The Hindu Business Line : Varishtha Pension Bima Yojana

WORRIED how you will sustain your lifestyle after the salary cheques stop coming? Are the retirement blues on you? The unveiling of the Varishtha Pension Bima Yojana scheme will bring some cheer to would-be pensioners. And why not? Offering a guaranteed 9 per cent rate of return over the plan life, its yields are better than most other fixed-income instruments available in the market. And what is more, the scheme also comes with the backing of the Government of India. This ensures that there is no default risk and makes one's investment safe.

Attractive as these features are, should all those over 55 and having funds make a beeline for the plan? We will look at various situations, when a person at the age of 55 years or above has Rs 3 lakh/Rs 6 lakh/over Rs 10 lakh to invest. We will also attempt to construct a portfolio that best suits the investors' interests.

Attractive yield, but...

The yield on this scheme is undoubtedly attractive, looked at in isolation. But there do exist such drawbacks as the extended period of lock-in and the fixed rate of interest over the entire duration of the 15-year term. Admittedly, it will be difficult to take a call on interest rate movement over 15 years.

Moreover, if the initial response to the scheme is anything to go by, the Government is looking at a sizeable subsidy bill (the Government will pay the difference between the guaranteed return and the return generated by LIC) a few years down the road. Revisiting the terms of this policy then and announcing a downward revision in the interest rate cannot be ruled out completely either.

Normally such rate cuts take effect prospectively. But if one considers the sacrifices that existing investors in UTI schemes and select small saving schemes have had to make, the possibility of any rate cut, taking effect even for existing investors, cannot be ruled out. This is a risk that investors need to factor in.

To get around the drawback of being locked in for an extended period as well as to benefit from a rise in interest rates, one can contemplate investments in such instruments as the Post-office Monthly Income Scheme (POMIS) and the Kisan Vikas Patra (KVP).

Advantage KVP and POMIS

The current rate on offer under POMIS is 8 per cent. But with a bonus of 10 per cent thrown in at maturity, the yield does exceed that of the Varishtha plan. The yield-to-maturity under this plan works out to 9.6 per cent.

A key advantage of the POMIS scheme, which has a six-year tenure, is its liquidity. If one is in urgent need of cash, this plan can be prematurely terminated, unlike the Varishtha plan. On termination between year one and three, 5 per cent of the deposited amount is deducted; for premature closure after year three, there is no deduction.

The flip side of the scheme is that returns are fixed only for a six-year term, and if one decides to re-enter subsequently, it may be at a lower rate.

Interest rates under this scheme have fallen 150 basis points since January 2001, when the rate on offer was 9.5 per cent. Further, sharp declines in the rate on offer may be unlikely over the next year or two with electoral compulsions likely to play a role in policy decisions.

Subsequently, the interest rates could decline to levels that are in line or carry a small premium over GoI paper for similar tenures. That said, one can also benefit with a rise in rates which can trigger a concurrent increase in the rates offered under the scheme.

But it is unlikely that the POMIS rates will head anywhere near the yields that were on offer three or five years ago. These aspects hold true for KVP as well.

Liquidity is also a feature of the KVP, under which a sum of money doubles in eight years and seven months (an 8.4 per cent return). Premature encashment is also possible; the extent of deduction would be a function of when the withdrawal is effected.

Choosing between schemes

To start off with, if you are one who is likely to incur a sizeable expenditure on, say, your daughter's marriage or for footing the fees for you son's education abroad, you will be better off by not parking a lumpsum under the Varishtha plan. The reason: The scheme's lack of liquidity. Remember, you can go in for a loan only after three years of depositing funds and that too at a rate of 10.5 per cent.

If such expenses are likely to crop up, you can opt for the POMIS scheme instead, which confers the benefit of high liquidity. Likewise, with the KVP.

If there is a likelihood of you having to seek recourse to the amount deposited under the Varishtha scheme to meet an exigency, you should accord priority to the other more-liquid plans.

Age is another crucial factor. The closer you are to the age specified for entry into the Varishtha plan, the more suitable the plan becomes, as the chances of taking the benefit over the entire 15-year term are better.

Key is amount available

For the various scenarios considered below, it has been assumed that the returns generated from one's investment will be utilised for consumption and not for reinvestment.

Small bulk amount: To arrive at a portfolio, let us consider the first case of a person having Rs 3 lakh to invest across various schemes. We will assume that this person receives a pension of Rs 5,000 per month from other sources. Therefore, one is not dependent on only the income that the investible surplus generates. In this case, skip the Varishtha plan and settle for either the POMIS scheme or a combination of the POMIS and the KVP (depending on your monthly financial requirement). This ensures that you have complete liquidity on the bulk amount available at your disposal.

Bulk amount: If you have a Rs 5-7 lakh corpus, you could go in for a mix of the Varishtha plan and POMIS/KVP. This style of investing will provide you with the twin advantages of a high yield on the Varishtha plan as well as the high liquidity of both the KVP and the POMIS.

Comfortable cushion: For those with a corpus of Rs 10 lakh and above, the best option will be to invest the maximum possible amount under the Varishtha plan and POMIS (Rs 2.66 lakh and Rs 3 lakh respectively), and park the rest in the KVP scheme and floating-rate debt funds. Select fixed deposits can also be considered. Across all these cases, clarity about one's financial requirements is an absolute imperative. If you are sure that you will not need to seek recourse to a certain portion of the investment corpus, that portion can then be stashed away in the Varishtha plan.

Pause and invest

Those who do not have the benefit of a regular monthly pension from other sources should weigh the pros and cons of the Varishtha plan carefully. Do not rush to take the higher interest rate available on Varishtha. It is important to look at the total amount available at your disposal and your needs of liquidity carefully.

Only if the amount available is large enough to make your Varishtha commitment, a small proportion of your investment (say, 15 to 20 per cent) should you go in for the plan. Do not place much store by the loan facility.

For the targeted age group, commitments to repay interest and principal can be difficult. Investing retirement funds is as much about generating reasonable returns to meet your needs of living as liquidity.

Basic features

Plan open to those aged 55 and above.

There is no ceiling on the age at which investors can enter this plan.

Guarantees a return of 9 per cent over the life of the plan.

Minimum and maximum monthly pensions of Rs 250 and Rs 2,000 respectively.

Minimum and maximum deposit of (for monthly pension option) of Rs 33,336 and Rs 2,66,665 respectively.

Yields improve if one opts to receive pensions quarterly, half-yearly or annually due to effect of monthly compounding.

Under the annual option, the effective yield is at 9.38 per cent per annum.

On the death of the policyholder, the beneficiary gets the initially deposited amount.

Exit option available only after 15 years.

Loans can be taken after three years. Loan amount of up to 75 per cent of the purchase price at a rate of 10.5 per cent. The interest rate will be decided by LIC from time to time.