Retirement mutual funds: Meaning, benefits, and types

Everybody dreams of retiring early, but very few start planning for it in time. Mutual funds for retirement offer a reliable avenue for building your future nest egg. Whether you’re years away from retirement or considerably closer to it – retirement funds can help you plan for this important milestone effectively and conveniently.

This article explains how these funds operate, their benefits, types, and how they can help you achieve your retirement objectives effectively.

Table of contents

• What are retirement mutual funds?
• How do retirement mutual funds work?
• Features of retirement mutual funds
• Advantages of Retirement Mutual Funds
• Types of retirement mutual funds
• Who should invest in retirement mutual funds?
• Taxation rules on retirement funds
• Factors you should know before investing
• How to invest in retirement funds?

What are retirement mutual funds?

Retirement funds are designed to support long-term savings with the option of generating a steady income stream, helping you lead a financially stable life post-retirement. These funds strike a balance between growth and risk management compared to general investment funds.

They invest in both equity and fixed-income instruments in varying proportions depending on the fund objective.

Also, fund managers can keep adjusting the allocation, moving from a relatively aggressive to a conservative stance as the maturity date approaches. Retirement mutual funds come with a lock-in period of five years or until retirement (whichever is earlier) and offer both lumpsum withdrawals and Systematic Withdrawal Plans (SWP) on maturity.

How do retirement mutual funds work?

Retirement mutual funds, especially hybrid retirement funds, invest in a diversified mix of equity and fixed-income securities based on their specific objectives. In the case of actively managed retirement funds, the fund manager continuously monitors market trends and the broader economic environment, adjusting the portfolio composition to optimise return potential while managing risk. The equity allocation within these funds drives growth, while the debt allocation ensures capital stability and offers the potential for steady income.

Fund managers also ensure diversification by allocating investments across different capitalisations, sectors, and maturities. However, active management can lead to higher costs, which may impact net returns over the long term. While investors can use convenient monthly SIPs to participate in retirement plans, most schemes come with fixed maturities, and premature redemptions are generally discouraged. Upon maturity, investors have the flexibility to choose between a lump-sum payout or a Systematic Withdrawal Plan (SWP).

Features of retirement mutual funds

Structured withdrawals: Options are available for lumpsum or periodic withdrawals, beginning at retirement age.

Extended lock-in periods: The longer tenure encourages the full positive impact of compounding interest.

Payout flexibility: Investors can choose between lumpsum payouts and annuities to suit their financial plans post-retirement.

Advantages of Retirement Mutual Funds

Mitigated risk: Investments often include relatively lower-risk assets, like government bonds, to deliver stable returns and prioritise capital preservation.

Insurance benefits: Some retirement investment funds also provide life insurance, supporting your retirement savings while offering financial cushion to families during unforeseen circumstances.

Rupee cost averaging: Regular contributions over a long period average out the cost of investment and reduce the impact of market volatility.

Tax benefits: Gains from equity-oriented mutual funds held for over 12 months are classified as long-term capital gains (LTCG) and taxed at 12.5%. Additionally, LTCG is tax-free up to Rs. 1.25 lakh annually.

Types of retirement mutual funds

Target-date funds: These funds gradually shift from growth investments to income-focused assets as retirement approaches.

Balanced Funds: These funds maintain a dynamic mix of equities and bonds, offering moderate growth potential with relatively less volatility.

Income-Oriented Funds: These funds invest in assets like high-yield bonds and dividend stocks, focusing on generating a steady income.

Who should invest in retirement mutual funds?

Retirement funds can be suitable for anyone looking to stabilize their financial future. They can be suitable for disciplined investors comfortable with their money being locked in for at least five years or until retirement. By staying invested in the long term, investors can optimize the benefits of compounding and enjoy rupee cost averaging.

Taxation of retirement mutual funds

Mutual funds are taxed as per their fund category and holding period are as follows:

1. Equity oriented mutual funds (investing 65% or more in equities):

• Short-term capital gains tax of 20% is levied on capital gains on units redeemed in less than 1 year.
• Long-term capital gains of 12.5% is levied on units redeemed after a year or more. Gains of up to Rs. 1.25 lakh are tax exempt.

2. Debt mutual funds (investing less than 35% in equities):

• Capital gains are deemed STCG regardless of holding period and taxed as per applicable income tax slab

3. Hybrid funds investing more than 35% but less than 65% in equities:

• STCG tax is levied on units held for less than 24 months. The rate is as per applicable income tax slab rate.
• LTCG tax of 12.5% is levied on units held for more than 24 months.

Factors you should know before investing

Personal financial assessment: Evaluate your financial goals, risk appetite, current financial standing, and timeline to retirement to choose a suitable fund.

Performance and costs: Consider the fund’s past performance and fees. Lower fees can enhance long-term investment growth.

Regulatory compliance: Ensure the fund complies with regulations and maintains transparent operations.

How to invest in retirement funds?

Steps to invest in retirement funds:

Research retirement mutual funds: Familiarize yourself with various retirement mutual funds and look at their portfolio composition – whether its equity-oriented, debt-oriented or a combination.

Choose a retirement mutual fund: Choose a fund that suits your retirement goals, risk tolerance, and investment horizon. Note that these funds come with a lock-in period of five years.

Investment options: You can invest either as a lump sum or through a Systematic Investment Plan (SIP), which allows you to invest fixed amounts regularly.

Choose platform:

AMCs: Invest directly through Asset Management Company websites.

Online platforms: Use various online platforms for convenient mutual fund investments.

Financial advisors: Consider working with a financial advisor to receive personalized guidance on selecting and investing in retirement mutual funds.

KYC compliance: Complete the Know Your Customer (KYC) process to meet regulatory requirements before you can proceed to make the investment.

Conclusion

Investing in a pension or retirement fund is an effective way to plan your financial future after retirement. With proper planning, this income can become a primary financial resource in your later years. In India, a variety of retirement plans are available to suit individual needs and preferences. Therefore, understanding the benefits of retirement planning and selecting the right mutual fund or pension plan is essential for maintaining financial stability during retirement.

FAQs:

What is the purpose of retirement funds?

The purpose of retirement funds is to provide financial stability during retirement, ensuring a consistent income to meet living expenses.

What are the risks with retirement funds?

The risks include market fluctuations, changes in interest rates, and inflation.

How much do you need for retirement?

The amount needed varies from person to person and there are several general recommendation, but it is better to have a customised plan tailored to your needs.

How much should you save and invest?

Consistently saving and investing a portion of your income early on helps leverage compounding. A rule of thumb is the 50/30/20 rule – 50% for needs, 30% for wants, and 20% for savings.

Is it beneficial to invest in retirement mutual funds?

Yes, these funds provide professional management and diversification necessary for creating long-term, inflation-beating wealth.

Who should invest in retirement mutual funds?

Retirement mutual funds suit long-term investors, those professional management, diversification, and disciplined investing through SIP. Since they have a five-year lock-in period, they may not be suitable for individuals needing immediate liquidity. Evaluating risk tolerance, time horizon, and financial goals is essential before investing.

What are the advantages of a retirement fund?

Retirement funds offer potential long-term growth, professional management, diversification and disciplined investing. However, they involve market risks, fees, and lock-in periods. Evaluating investment choices based on financial goals, risk tolerance, and time horizon is crucial.

Are retirement funds risky?

The risk of retirement funds depends on asset allocation, investment style and market conditions. Equity-heavy funds carry higher risk but offer better long-term growth potential, while debt-heavy funds are relatively stable but return potential may not outpace inflation. Diversification, regular reviews, and professional advice can help manage risk effectively.

Mutual Fund investments are subject to market risks, read all scheme related documents carefully.
This document should not be treated as endorsement of the views/opinions or as investment advice. This document should not be construed as a research report or a recommendation to buy or sell any security. This document is for information purpose only and should not be construed as a promise on minimum returns or safeguard of capital. This document alone is not sufficient and should not be used for the development or implementation of an investment strategy. The recipient should note and understand that the information provided above may not contain all the material aspects relevant for making an investment decision. Investors are advised to consult their own investment advisor before making any investment decision in light of their risk appetite, investment goals and horizon. This information is subject to change without any prior notice.