MF analysis: Retirement funds are key to comfort during the sunset years

‘’The goal of retirement is to live off your assets, not on them” - Frank Eberhart

Retirement, a word that evokes excitement and anxiety simultaneously, and needs financial planning well in advance. Mutual fund ads often show happy, older couples going on holidays, taking cruises, living a normal, comfortable life. Is that possible to achieve? The sunset years are a time without earnings but with higher health expenses, when one needs a regular pension income and the backing of a sizeable corpus. This is where retirement focused mutual funds can make a difference (See top retirement mutual funds)

Most retirement funds are either debt funds, hybrid funds, equity funds or a combination of funds with varied asset allocation along with the option of a systematic withdrawal plan. These funds fall in the SEBI category of solution-oriented funds.

Salient Features at a glance:

Higher flexibility in withdrawal compared to pension funds like NPS. One can also redeem one’s holdings and switch to another mutual fund
Certain funds offer the option to switch between funds with gradually reduced exposure to high risk equity as retirement approaches
Retirement funds carry a lock-in period of five years or until retirement, whichever is earlier.
Exit load of 3-4% in case of premature withdrawal
The longer lock-in period and higher exit load levied is to discourage premature withdrawal of retirement funds
Many funds have options suited to the risk appetite of the investor like conservative, moderate and aggressive/progressive plans
Retirement funds fall under goal-based investments, which helps instill financial discipline while investing
Certain funds offer the feature of auto-switch option i.e. rebalance the portfolio based on age, life stage and risk metrics between equity-debt
Fund manager aims to minimise fluctuations in NAV
The fund management expenses are higher than the charges for NPS
Suitable for moderate to low risk investors with 40% equity exposure as against 65% in hybrid funds
Owing to the moderate risk associated with such instruments, the returns generated are lower than pure equity funds
Option to withdraw lump sum at maturity
Not suited for investors looking at a short-term investment horizon owing to limited liquidity

Investment Rationale:

Option for Systematic Withdrawal Plan (SWPs): Most retirement funds have an in-built option of SWP at the time of retirement, which may offer cash-payouts or dividends at regular intervals. Systematic withdrawals are not subject to TDS, with capital gains tax liable on withdrawn amounts. SWPs even offer the option to withdraw the capital appreciation amount and retain one’s capital invested in the mutual fund.
Suited for long term horizons: Financial planning for retirement requires considerable financial discipline by starting to invest early, regular investment and refraining from withdrawing one’s retirement corpus. Retirement planning is a long-term goal. Accordingly, retirement funds are aimed at long term wealth creation.
Risks involved: The main risk is inflation, owing to the prolonged time period of investment. Thus, one needs to select a mix of equity and debt with reduced equity exposure as one nears retirement.
Earn compounding returns: Given the long investment period, retirement funds offer opportunity to derive compounded returns and build a sizeable corpus.
Diversification benefit: Retirement funds offer a diversification advantage across asset classes. Note that systematic risk affects the markets uniformly and cannot be eliminated by diversification.
Transparency: Retirement funds offer higher transparency than pension funds with declaration of the holding mix, NAV values at regular intervals.
Evaluating funds: The investor needs to decide a fund based on the desired corpus sum and other parameters like the track record of the fund manager in delivering returns, withdrawal conditions and charges, fund management expenses and risks.
Taxes that need to be paid: Long term capital gains in case of equity funds are taxable for gains in excess of Rs 1 lakh, and with indexation on gains from debt funds. Eligible for tax benefits u/s 80C of the Income Tax Act. The investor is liable to capital gains tax at the time of each switch over.

Advantage of professional fund management: The investor can benefit from the expertise of professional fund managers, who would manage the asset allocation, portfolio rebalancing and risk mitigation aspects of the retirement fund. The returns would generally be higher than those from an insurance-based pension product.