What Is Pension Meaning

What is Pension? Know Pension Meaning and it’s Definition

Pensions are crucial financial tools for securing retirement. They offer options like annuities to build a stable post-employment financial portfolio.

Written by : Raman Sharma

Reviewed by : Gaurav Nagpal

Gaurav Nagpal

2022-06-01

854 Views

11 minutes read

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A pension is a fixed retirement fund for an employee paid as a regular income at regular intervals during his post-retirement years. A pension is a fund where a sum of money is added by the employer, employee, or both.

A pension is a testament to your retirement plan during your employment years. Retirement is your second inning, during which you want to fulfil your long-awaited dreams and spend time with your loved ones. However, you can only do it if you prepare for it. Your pension defines the quality of your retirement. To secure your post-retirement life, you need to start thinking about the pension.

Once you retire, a pension is your major source of income, and your savings at the time of retirement will ultimately define it. Also, you don't know how long you are going to live. You must have an adequate corpus and a recurring income.

Table Of Content:

What is Pension?

The easiest pension definition is the regular monthly income you generate out of your saved corpus, usually after retirement. You usually build the corpus during your active employment. Your employer may also contribute to your retirement corpus.

Upon retirement, you can invest a part of your retirement corpus into a pension or annuity plan. The plan allows you to safely invest your precious retirement corpus for a long time, even for a lifetime. The plan will then start offering you a regular monthly or quarterly income.

You can also choose to have a growing pension to compensate for inflation.

How does a Pension Plan Work?

A pension helps you generate regular income after your retirement. The working of pension is different and varies from plan to plan. However, the underlying working is the same.

You invest an amount in a pension plan regularly over the years, and it grows to create a sizable fund for you. Upon retirement, you can use the created corpus to buy an annuity, and based on the plan you have selected, you start receiving the pension.

Types of Pension Plan

A pension scheme or plan helps you focus on yourself post your retirement. With a regular income, you do not have to worry about the money and can focus on things you love doing. There are different types of pension plans you can invest in to receive the pension after you retire.

  1. Annuity Plans: These are pension plans that provide you with a regular income stream. You buy an annuity plan and pay a premium amount or make a one-time lump sum payment to the insurance company. The insurance company, in return, pays your regular income. Depending on the type, an annuity can start immediately or on a future date.
  2. Social Security Schemes: The Government of India offers a variety of social security schemes, including pension schemes that help you invest today to secure your future. One example is the Atal Pension Yojana. You invest a certain amount in the scheme, and you receive a guaranteed pension after 60 years of age.
  3. Deferred Annuity: A deferred Annuity is a type of pension plan where the pension starts a few years after the investment. For example, you can invest Rs 10 lakhs now, and the monthly income will start five years later.
  4. Immediate Annuity: An immediate annuity is a pension plan where your monthly, quarterly or yearly annuity starts with the investment. For example, you invest Rs 10 lakhs and start to receive a monthly pension after 30 days of investment.
  5. Annuity Certain: Annuity Certain is the type of annuity plan which provides regular income for a limited period. For example, investing a lump sum money to receive a fixed income for ten years. At the end of the term, you will receive the remaining balance.
  6. Pension Plan with Life Cover: These are pension plans where primary account holders or joint holders will also have life coverage. If they die during the plan’s term, the policy will pay the death benefit amounts to their nominees.
  7. Life Annuity: A life annuity can be a deferred or immediate annuity that will continue to pay income until the policyholder's demise. Upon the death of the policyholder, the balance funds are paid to the nominee.
  8. Guaranteed Period Annuity: Guaranteed period annuity is an annuity that will continue even if the policyholder dies within the guaranteed period. Usually, other annuities require the policyholder to submit proof of living every year to continue receiving an annuity. A guaranteed period of annuity releases you from the obligation for at least a few years.

Did You Know?

In India, NPS allows individuals to choose between equity, corporate bonds, and government securities for investment, offering flexibility and potential growth.

Source: NPS

Claim Settlement Ratio

How to Build Corpus for your Retirement with a Pension Plan?

To build a corpus for your pension, you can invest in one or more options available to you. You can select the ones that are in line with your financial needs:

1. National Pension Scheme (NPS)

You can open an NPS account and invest in them while you are working. Your investment is divided into equity and debt and grows over time. On maturity (60 years), you can withdraw up to 60% of the accumulated corpus in a lump sum. You need to buy an annuity plan with the remaining corpus which helps you generate regular income.

  • Life-stage portfolio allocation

  • Exposure to alternative assets

  • Choose from aggressive to safe portfolios

  • Benefit from market-linked returns 

Learn more about National Pension Scheme.

2. Public Provident Fund (PPF)

This provides you with secured returns over the long term and gives you a great investment option for building a corpus for pension. You have to remain invested in these schemes for 15 years.

  • Tax-free growth and maturity value

  • Partial withdrawals are allowed from the sixth financial year of investment

  • Extension in batches of five years after maturity

3. United Linked Insurance Plan (ULIP)

If you are looking to grow your retirement corpus aggressively, you can opt for ULIP as it lets you invest in stocks, bonds, and other financial instruments. You also get life insurance, and the premium you pay is eligible for a tax deduction.

  • Hold up to 99 years of age

  • Partial tax-free withdrawals are possible after five-year lock-in

  • Invest in aggressive and safe portfolios

  • Manage your allocation automatically 

  • Bonus additions for long-term investors

  • Safety of life cover for family members

How to Choose the Best Retirement Pension Plan?

The right time to start planning for retirement is as soon as your start earning. You can choose the best retirement plan based on the below parameters:

1. Time to Retirement

The first and the most important thing to consider is your retirement age. Some people want to retire at 60, while others want to retire earlier. Knowing the years before your retirement helps you choose the right pension plan.

2. Inflation

The money you are investing today should be sufficient to help you live the life of your choice post-retirement. Inflation reduces your purchasing power and lowers the value of money. Your pension plan should grow at a rate higher than inflation.

Why should you consider inflation while planning for retirement.

3. Asset Allocation

Different individuals have different risk profiles. Your pension plan should allow you to choose your asset allocation. If you are starting early and your retirement has time, you can be a bit aggressive. As you come close to your retirement years, your pension plan should allow you to move your assets to safer options.

4. Added Benefits

You can plan for retirement, but there can be some unexpected events in life. Your retirement plan should cover you and your family from unexpected life events through added benefits like life cover and protection against illnesses.

For example, ULIPs like Invest 4G from Canara HSBC Bank of Commerce Life Insurance offer bonus additions for long-term investors.

5. Same Plan to Draw Pension

Once you have created a retirement corpus, you have to start a pension. Your pension plan should have the feature to convert your corpus to a pension. If not, you will have a tough time deciding how and where to invest the accumulated corpus for the pension.

For example, you can use both Invest 4G ULIP and PPF for tax-free partial withdrawals.

6. Taxability

Last on the list, but every essential parameter to consider is taxability. The premium (investment) you make towards your pension plan should be eligible for a tax deduction.

At some point, you will have to retire. If you don't want to worry about your financial needs post-retirement, you need to invest in pension plans. The sooner you start planning for retirement, the easier it gets. Pension gives you financial security and the freedom to live your life the way you want to.

Wrapping Up

Securing a comfortable and fulfilling retirement requires careful planning and investment in the right pension schemes. While understanding the pension meaning and options ranging from annuity plans and social security schemes to NPS, PPF, and ULIPs, there are numerous ways to build a substantial retirement corpus. Key considerations such as retirement age, inflation, asset allocation, added benefits, ease of converting corpus to pension, and taxability should guide your choice and give the answer to the question, what is pension?

Starting early and selecting a plan that aligns with your financial goals and risk appetite can ensure a steady, reliable income post-retirement, enabling you to enjoy your golden years without financial worries.

Glossary:

  • Corpus: The total amount of money saved or invested, typically used to refer to the fund accumulated for retirement.
  • National Pension Scheme (NPS): A government-sponsored pension scheme in India that allows individuals to invest in equity and debt to build a retirement corpus
  • Public Provident Fund (PPF): A long-term savings scheme in India that provides tax-free returns and is used to build a retirement corpus.

  • Asset Allocation: The process of deciding how to distribute investments among different asset categories like equities, bonds, and cash, based on an individual’s risk tolerance and time horizon.

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FAQs related to Pension

A pension is a retirement fund that provides regular income after you retire. It is typically funded by contributions from your employer, yourself, or both during your working years. The money is invested and grows over time, and upon retirement, it is used to provide you with a steady income, ensuring financial security in your post-retirement years.

There are several types of pensions:
 

  • Annuity Plans: Provide regular income from a premium or lump sum payment.
  • Social Security Schemes: Offer government-guaranteed pensions like the Atal Pension Yojana.
  • Deferred Annuity plans: Start payments several years after the initial investment.
  • Immediate Annuity plans: Begin payments shortly after investment.
  • Annuity Certain: Offers fixed income for a specific period.
  • Pension Plans with Life Cover: Include death benefits for nominees. 
  • Life Annuity plans: Continue payments until the policyholder's death. 
  • Guaranteed Period Annuity:  Ensures payments for a set period even if the policyholder dies.

 

No, a pension is not a salary. A pension is a retirement fund that provides regular income after you retire, based on the contributions made by you and/or your employer during your working years. In contrast, a salary is the regular payment you receive from your employer while you are actively employed.

Yes, having a pension plan in addition to a Provident Fund (PF) can be beneficial. While PF provides a lump sum amount at retirement, a pension plan ensures a steady income stream throughout your retirement years. Combining both can enhance your financial security, helping you cover ongoing expenses and maintain your desired lifestyle post-retirement.

A pension plan and a term plan serve different financial purposes:
 

  • Pension Plan: Provides regular income during retirement, accumulated through contributions over your working years.
  • Term Plan: This plan offers a lump sum to beneficiaries if you die within the policy term, providing financial security to your family

In essence, a pension plan provides income during retirement, while a term plan provides financial protection to loved ones in case of your death. Both are important components of financial planning, addressing different aspects of financial security across different life stages.

An annuity is a financial product designed to provide regular payments to an individual over a specified period, often for the rest of their life. It is typically purchased with a lump sum or through regular premiums. Annuities are commonly used as a retirement income strategy, ensuring a steady stream of income after the individual stops working.