Don’t lose Big time by not commuting your Additional Pension – Part 2
Col Sanjeev Govila (retd), CEO, Hum Fauji Initiatives
Dear Friends,
I have been writing on the subject of commutation of pension for quite sometime and the reasons why commutation of pension (and the subsequent additional commutation of pension consequent to option given under 7th CPC to officers retired on or after 1st Jan 2016) would be a good idea. Please refer my last article available at http://humfauji.in/commutation-of-pension/.
I had got many counters and replies to that article through different media. It was so very heartening to see a healthy debate taking place among faujis on a purely financial subject. This is quite a departure from the past where nobody talked about money, nobody read about money and consequently, nobody knew about money and its management in fauji community….ever. Defintely a very positive development now.
On the other hand, I would attempt to once again bring out the rationale for I persistently recommending commutation of pension.
Commutation is like taking a loan from the Govt at about 8.6% per annum:
• the Govt gives you a bulk amount (ie, next 15 year’s pension is given in a lump sum today),
• you pay a certain EMI (ie, a constant amount taken out from your pension over those 15 years),
• after 15 years, the loan gets fully paid and the reduction in your pension is restored back (implying no further EMI is to be paid).
*There is a sweetener to this loan:* The 8.6% interest rate also includes the cost of a surety that if something happens to you during the loan period, your family doesn’t have to return anything and the EMIs will also not be deducted any longer.
*Let me add another sweetner to it:* If you don’t take the loan, the EMIs that you don’t pay (ie the non-commuted pension that you get) will be taxable but if you take the loan, the loan amount given to you is tax-free? And if you get a good person to advise you or if you are yourself financially savvy enough, you may not pay any tax on the returns that you generate from the loan amount for most of the time while still being invested in a very safe manner!
*I again add one more sweetner:* If you invest this loan amount even at a safe 7% interest rate, you can get the very same monthly returns as the part of pension you’ve been missing out due to commutation and still have Rs 25 – 29 Lakhs extra left at the end of the loan period of 15 years? Alternatively, you can get additional pension of about Rs 9-10,000 per month if you do not want more monthly money now and do not care for any balance amount at the end of 15 years.
If you read and understand the above carefully, you will find that you are actually a loser if you do not commute! Does pension commutation really seem like a bad deal? I think, all, except only some scepticals, would go in for such a low cost loan with such a surety. Hundreds of officers have taken huge home, car, personal and credit car loans at much higher rates of interest and with no such surety, unless they take a separate insurance to cover the loan.
Of course, if you take the commutation amount and then invest it in tax-inefficient products like bank FDs, Post Office Monthly Income Scheme (PO MIS), Senior Citizen Savings Scheme (SCSS) etc, then it is better that you do not commute. The reason is that these three ‘popular’ investment products will actually give you just 5%, 6.24% and 6.72% returns respectively if we assume all officers will be at least in the 20% tax bracket. And if you happen to be in 30% tax bracket due to re-employment or any other civil employment, your returns further dwindle down to 4.55%, 5.46% and 5.88% respectively.
*What about the officers who have tax-free pension due to gallantry awards or disability pension? *
It makes all the more sense for them to commute since they get the tax edge and can invest even in POMIS and SCSS though the investment amount in these schemes is limited to Rs 4.5 Lakhs per head and Rs 15 lakhs respectively. They should still shun bank FDs due to their low returns. However if you decide to go in for professional advice and take a cutomised mutual fund portfolio with an optimum mix of Debt Funds and Equity Funds (if you’re comfortable with them) as per your needs and comfort level, you would be much better off.
The question that now arises is, if commutation is so good, why are few people opposing it vehemently. I could think of only two reasons.
First reason could be their pre-supposition that faujis are a gullible lot, have no financial knowledge and can be easily misled by others – hence, they should not attempt to take this bulk amount since they would not be able to invest it properly! This is not true, as has been my experience of dealing with hundreds of officers and their families over the past eight years, and managing assets worth over Rs 300 Crores of more than 1500 fauji investors as on today. Most of the officers know what is good for them and what is not, even when they may not themselves be very financially savvy.
Second reason for this opposition could be the limited financial knowledge of the people who are opposing it, wherein they are working on absolute figures in dealing with long term money rather than bringing it down to a common percentage factor, as is done for easy comparison of products. They could also be pushing their argument just to justify a stand they’ve already taken. This is being done by brandishing absolute figures to make the situation look alarming – one such article says that, out of the balance Rs 98 lacs due to an officer, the govt pays only Rs 54 Lakhs upfront on retirement and retains the balance Rs 44 Lakhs. Please remember that if you have taken a loan of Rs 54 Lakhs from any agency at 8.6% for 15 years in the normal course, you would have paid the lender a total of Rs 98 Lakhs, which is Rs 44 Lakhs extra. There is nothing extraordinary about it and all of us have been doing it all our life when we take a loan. And normal loans do not come with the sweetners coming with pension commutation which I’ve already written about earlier in this article. And the loans do not automatically come with life insurance too.
Also be aware that the cheapest rate at which vehicle loans are today being given by banks like SBI is 9.25% and the personal loans are at least at 12.5%. Large number of officers take such loans routinely. Thus to say that this loan (ie, commutation of pension) is bad just because the lender (Govt in this case) takes its part of the interest, is a very naïve argument. Probably the people opposing it have the mentality – ‘Oh! How can the Govt earn any rate of interest from its citizens? Govt is always meant to give free lunches!’. Don’t forget that your various loans from AGIF/AFGIS/NGIS come at similar or higher rates of interest.
*Finally our Recommendations repeated yet again*
We strongly recommend that all officers should commute their pension to the maximum allowed 50%. If the officers are also able to invest their commuted pension bulk amount wisely and carefully, there is not likely to be any difference in their take-home pension even after commutation while still having this large commuted amount with them as an additional reserve.
