A pension plan is essential to help you live a financially independent life after retirement. Thus, it is important to understand how a pension plan works.

If you want to know more about pension plans, then read this article.

Everyone wants to live a stress-free life after retirement. Therefore, it is important to start planning retirement as early as possible to ensure financial security. One of the ways to achieve it is by investing in a pension plan.

What is a Pension Plan?

Generally, pension plans provide insurance as well as investment benefits. In case of such plans, you are required to make regular investments over a fixed term. Once you retire, you will start receiving a pension on a regular basis. Furthermore, it is recommended to start investing in a pension plan from an early age because it helps build a significant financial corpus.

Typically, there are two phases in a pension plan-

• Accumulation Phase

In this phase, the individual needs to pay premiums until he/she retires.

• Vesting Phase

The vesting phase starts when the individual retires. From this age, the retiree will receive a pension until he/she dies.

Before you know how a pension plan works, you need to understand a few important things about it-

Accumulation Phase

The premiums paid by the individual during this phase are invested in some financial units. This is done to earn interest.

Look for an Annuity Plan

When the investor retires, the insurance company allows him/her to withdraw a specific amount of the accumulated money. The investor needs to buy an annuity plan at a suitable interest rate with the rest of the funds. Based on this annuity plan, he/she will get a regular income source.

There are No Tax Benefits with Regular Pension Plans

While the investor is eligible to get a tax benefit for paying premiums for a pension plan, this benefit isn’t applicable when receiving a pension. The individual will have to pay tax based on the tax rate slabs of senior and super senior citizens when receiving pension during the annuity period.

How Does a Pension Plan Work?

Let’s take a look at an example to understand how a pension plan works in India-

Mr. Ali is 30 years old. He currently earns Rs. 50,000 per month. He wants to retire at the age of 60, and his expected lifespan is 80. He wants to receive a monthly income of Rs. 50,000 per month after retirement.

In order to get Rs. 50,000 every month until he is 80 years old, he will require a corpus of Rs. 7.5 crore after considering inflation at 6%. If the returns are considered 12% until the age of 60 and 5% after retirement, then Mr. Ali needs to invest Rs. 20,000 every month to build the corpus.

Get a Pension Plan for Financial Independence After Retirement

In order to get financial security post-retirement, you need to buy a pension plan. Furthermore, it is recommended that you start investing from an early age to build a significant corpus.