Retirement Mutual Funds

Investors turn to mutual funds to meet many of their financial goals and needs, and retirement planning is another crucial financial goal that requires advanced planning to ensure that one is able to preserve his or her lifestyle in post-retirement life.

Retirement mutual funds can be the key to a secure, worry-free future. But what exactly makes these funds such a crucial part of planning for your golden years? Let's understand in detail the features of retirement mutual funds and uncover their role in safeguarding your future.

What is a Retirement Mutual Fund?

A retirement fund is a type of investment instrument that allows individuals to save for retirement. These funds generally offer regular income to retirees after they reach the age of 58 or 60.

Retirement funds, also known as pension funds, are open-ended mutual funds. These funds allocate to both stocks and bonds to generate returns but generally shift towards lower-risk options, such as government securities, as retirement age nears. 

Furthermore, retirement mutual funds have a lock-in period of up to five years or until the retirement age is reached. They offer many benefits, including tax benefits, low expense ratio and professional management.

Features of Retirement Mutual Funds

Here are the key characteristics of retirement funds:

Less Risky: These funds invest in low-risk investment options to generate steady returns, making them an ideal investment choice for those planning for retirement. While these funds may have some money invested in stocks, it’s generally on the lower side to ensure the safety of your investments.

Lock-in Period: Retirement mutual funds have a lock-in period of five years or more. This ensures your money is invested for long periods and you are able to enjoy the benefit of compounding. Moreover, a longer investment period also smoothens the impact of short-term market fluctuation. These funds are made for investors with longer-term investment horizons.

Hybrid Nature: Asset management companies (AMCs) now offer hybrid pension plans. These funds put money in both debt and equity markets. They carefully allocate investments to achieve both growth and financial security, tailored to your retirement needs.

Withdrawal Conditions: Ideally, investors should refrain from withdrawing funds from retirement plans before the retirement age of 58-60 years. Investors have the option to either withdraw a full lump sum amount or receive monthly annuity payments, depending on their preferences and financial goals.

Liquidity: Pension funds typically have low liquidity as there are charges and penalties for early withdrawal. Investors must carefully evaluate their investment requirements and thoroughly understand these conditions before committing to a retirement fund.

Automatic Rebalancing: These funds modify their asset allocation according to an individual’s age. Younger investors have a higher allocation to stocks to ensure strong capital appreciation, while older investors have a higher investment in bonds to provide stability. Therefore, as retirement age nears, these funds shift investments to fixed-income securities from stocks.
 

How Does Retirement Fund Work?

Retirement mutual funds are a great way to save periodically for your retirement. Herein, you regularly contribute your money to the fund right up to your retirement age. These funds then pool your money with that of other investors and use it to invest in a variety of investments like stocks, bonds or other assets. 

The returns from these investments—interest, dividends, or capital gains—are reinvested into the fund, which helps your savings grow faster. Over time, the fund may adjust its investments. Initially, the same fund manager may invest a higher quantum in stocks and eventually transition to bonds, especially as you get closer to retirement.

Upon retirement, you can access the money all at once as a lump sum or as a monthly annuity, depending on your choice.

Advantages of Retirement Funds

Here are a few benefits of investing in a retirement mutual fund:

Flexibility: A main advantage of retirement funds is that investors can choose the asset allocation strategy according to their risk profile. Moreover, unlike a few retirement plans like the National Pension Scheme NPS that need investors to compulsorily buy an annuity, these funds allow investors to choose how to withdraw their money — either as a lump sum or through regular payments — giving flexibility in managing their retirement income.

Tax Benefit: Certain retirement funds offer tax benefits under Section 80C of the Income Tax Act. Therefore, you can lower your taxable income by investing in a retirement fund. However, note that redemption of these funds will attract a tax.

Long-Term Investing

Retirement funds are designed with a long-term perspective, which helps in building wealth steadily over time. 

Insurance Cover: Most pension funds or plans offer a life insurance cover, ensuring financial safety for the dependents in case of the fundholders’ demise before retiring. Also, some policies allow the investor to withdraw lump sum money in case the funds are needed to meet expenses for a medical emergency. 

Low-Risk Investment: Retirement funds are among the safest investment avenues as they have a low-risk profile. Opting for debt-based retirement plans can offer stability and fixed returns. Whereas, investors seeking better returns without taking too much risk can opt for a hybrid fund that invests in debt and equity.

Risks of Investing In Retirement Funds

While there are many benefits of investing in retirement funds, they are also subject to a few risks, such as:

Longevity Risk: There is a possibility that you may outlive your savings. In case your retirement funds don’t last as long as you live, then you may face financial challenges in the later stage of life.

Market Risk: The value of the investments in the fund can fluctuate based on market conditions. Economic downturns or poor market performance can decrease the value of your retirement savings.

Inflation Risk: Inflation can erode the purchasing power of your retirement savings over time. If a fund offers a fixed monthly/annual income, then the real value of your payments could decline in case the pace of inflation growth remains high.

Liquidity Risk: Retirement funds may have restrictions on withdrawals or may involve penalties for early withdrawals before retirement. Therefore, consider your liquidity needs along with your investment horizon as premature withdrawals could impact your returns.

Who Should Invest in Retirement Mutual Funds?

Retirement mutual funds are designed to help you build a steady income for your retirement years when you might not have a regular paycheck. Investors who need a steady income stream in the golden years of their life can look to opt for these funds. Some pension mutual funds also adjust for inflation as the cost of living increases.

These funds are suitable for long-term planners who are comfortable setting aside money for the long haul. Most retirement funds have a lock-in period of up to five years, ensuring that you don’t take your money out too soon, allowing it to grow.

There are different types of retirement plans to suit your needs. For risk-averse investors, funds that only invest in debt instruments could be the right choice. While they may offer lower returns, the risk of investing in them is also low. If you’re okay with taking on some risk for potentially higher returns, consider funds that invest in both debt and equity.

Moreover, pension funds can offer a disciplined and convenient way of building a retirement corpus as you consistently and periodically invest in these funds. Since these funds are professionally managed, you don’t need to research to find the right investments.

Taxability of Retirement Mutual Funds

Retirement funds are a tax-efficient choice as some of these mutual funds allow a tax deduction benefit of up to ₹1.5 lakh every financial year under Section 80C. This benefit applies to new investments and renewal of existing plans. However, once you start earning an annuity, the income will taxed as per your prevailing income tax slab.

Withdrawals from retirement funds will have the following tax implications:

Equity Retirement Fund

If you redeem your investment within 12 months from the date of investment, any gains made are subject to a short-term capital gains tax of 20%. However, if you redeem your investments after a period of 12 months, any gains up to ₹1.25 lakh are exempt from taxes and gains above that attract a tax rate of 12.5%.

Debt Retirement Fund

If you have invested in a debt retirement fund before April 1, 2023, then the tax implications are as follows:

Short-term capital gains: If you withdraw fund units before 24 months, any investment gains made are added to the income and taxed as per the marginal tax rate.

Long-term capital gains: If you redeem fund units after 24 months, any gains made are taxable at 12.5% with no indexation benefit.

However, investments made on or after April 1, 2023, are taxed at a marginal tax rate irrespective of the holding period.

How to Invest in Retirement Funds?

If you are looking to invest in the best retirement funds through INDmoney app, follow these steps:

• Open the app and log in with your credentials.
• Navigate to the "Mutual Funds" section within the app.
• Use the filter to select "Retirement Mutual Funds" to view the available choices.
• Decide between a lump sum investment or a Systematic Investment Plan (SIP) for regular investments.
• Enter the desired investment amount and confirm the transaction.