What Is Pension Plan and How Does It Work?

Retirement planning is not just about living a comfortable life pursuing your hobbies. It also means being financially independent and debt-free. The best way to achieve this is to invest in a pension plan from an early age. Read on to know more about it.

Everyone dreams of living a financially independent life after retirement. But, only a few succeed, while others tend to be dependent on their children. These are the people who plan their retirement from an early age and start investing in a pension plan. Today, there are different types of pension schemes in India that allow you to get a steady income after you attain the retirement age. To make the most of these plans, you must understand the working of different plans and choose the right one to suit your specific needs. 

What is a pension plan?

A pension plan or retirement plan generally comes with many benefits such as insurance protection and return on investment. These plans require you to pay a fixed sum regularly over a specified duration. When you attain retirement, you get a regular income on a monthly or yearly basis as a pension based on the scheme’s terms and conditions.

Some pension plans offer a lump sum payout upon maturity, or when you attain retirement age. But, to get decent returns from your pension plan, it is paramount that you start investing in such plans from an early age and leverage the benefit of time to allow your money to grow with a compounding effect.

Investing in the pension plan for 30-40 years can help you accumulate adequate corpus to tackle the constantly rising inflation and meet your regular expenses and emergency expenses like medical costs during old age. 

Working of a pension plan

Now that you understand what a pension plan is, it would help you to understand the working of such plans as different plans work differently. Let us know the working of a pension plan with an example of an investment in a Unit Linked Insurance Plan or ULIP.

Assume that your current age is 32, and your monthly income is Rs. 50,000. Now, if your expected lifespan is 80 years and you wish to retire at 60, how much do you think you must invest every month for the next 28 years (until you reach the retirement age) to draw a monthly income of Rs. 50,000 after you retire?

Let us consider the annual inflation to be at 6%. This means you will roughly need a corpus of about 7.15 crore to get a monthly income of Rs. 50,000 after your retirement. So, if you start investing now in a ULIP, and you retire at the age of 60, you must invest about Rs. 26,000 every month to reach your target.

If all the factors are kept constant, and you start investing when you are 30 years old, the monthly investment amount would be roughly Rs. 20,000. This is how a pension plan works. The earlier you start, the more beneficial.

Suppose you think the manual calculation is confusing. In that case, you can use the retirement plan calculator or pension fund calculator to know the exact amount you must invest to get the desired pension. 

Who should invest in a pension plan?

Irrespective of whether they are a salaried employee or a self-employed professional, every individual must invest in a pension plan to secure their finances post-retirement. But, the type of plan you choose plays an important role in giving you the desired corpus. You must do your due diligence in learning about the different pension plans and choose the one that perfectly aligns with your retirement goals.

For example, if you wish to retire early, say at the age of 50, you must create enough corpus to support your retired life. Hence, the key is to be smart and prudent with your retirement plan.