Voluntary Retirement Scheme
Retirement is closer than we think. Especially for those opting for the Voluntary Retirement Scheme (VRS). VRS is a scheme offered by employers to incentivise long-term employees to retire early. Normally, employees stay in the workforce until they attain superannuation (i.e. turn 60). Through the voluntary retirement scheme, employees who are as young as forty years may also retire. Here’s everything that you need to know about VRS.
Who can opt for VRS?
Benefits of VRS
Voluntary Retirement Scheme Calculation
Let’s assume Sathya, aged 55 has been working with his current employer for the last 15 years and has 5 years of service left before retirement. He is eligible for VRS as he has never opted for VRS before and fulfils the other criteria. His employer is offering him a VRS benefit of Rs. 32 Lakhs. If his current salary is Rs. 60,000 per month, what is the tax-free VRS?
There are three components to determining the tax-free component of VRS (Voluntary Retirement Scheme).
So, in Sathya’s case, his tax-free VRS is Rs. 5 Lakhs and he must pay tax on the balance Rs. 27 Lakhs. The amount of VRS someone is eligible for is dependent on the employer’s VRS policy, number of years in service, the number of years to retirement and their current income.
An employee who has claimed exemption under Section 10 (10C) of up to ₹5 lakh in an assessment year, will not be allowed to claim it in any other assessment year.
Regardless of whether one is planning their retirement or opting for VRS, a smart way to build the retirement corpus would be through tax planning. Proper tax planning could build a nest egg. The three investments that should form the core retirement portfolio are:
National Pension Scheme (NPS):
NPS is an essential component of the retirement corpus. Up to 10% of the employee’s wages can be contributed by the employer to a corporate NPS. This amount is eligible as a deduction from the employee’s income. Over and above this, a benefit of Rs. 50,000 as a deduction is available under Section 80 CCD.
NPS investments are a defined contribution scheme. Since this is a retirement investment, an investor is encouraged to withdraw investments from the NPS upon superannuation (turning 60 years old). At this point, the investor may withdraw up to 60% of the accumulated corpus without any tax. The balance 40% should be used to purchase an annuity. The income received from the annuity is taxable.
An investor who opts for premature withdrawal of NPS must convert at least 80% of the accumulated corpus into an annuity and can commute the balance as a lump sum. Premature withdrawal can be done only if the subscriber has completed 10 years with the NPS.
NPS is a perfect retirement instrument as the investor could choose their asset allocation across equities, government bonds, and corporate bonds every year. Alternatively, they could choose an automatic asset allocation product that will adjust the weights according to the investor’s age. After retirement, the annuity portion of the NPS investments would provide a regular stream of income.
Equity Linked Savings Scheme (ELSS):
ELSS is a special category of Mutual Funds with tax benefits. ELSS funds offer market-linked returns and have the lowest lock-in period (3 years) for tax-saving investments under section 80 C. Apart from NPS, ELSS is the only other tax saving instrument to offers exposure to equity instruments.
Provident funds through the EPF or PPF are a good way to build long-term debt portfolio. The interest earned on provident funds and maturity proceeds is tax-free. Contributions to these provident funds are eligible for deduction under Section 80 C for up to Rs. 1.5 Lakhs.
Someone opting for VRS with the intent of retiring needs an early retirement plan. Ideally, for retirement planning a runway of at least 15 years is required. So, for those thinking about early retirement, it helps to start planning from today. For early retirement, the key is to manage the retirement corpus well. This means identifying a sustainable amount that can be withdrawn from the corpus. In Sathya’s case, he might need to draw down from the retirement corpus for the next 25-30 years.
Essential to every retirement strategy is to play it safe. Your retirement corpus is your life’s savings. The aim is to beat inflation and live well off the accumulated assets. It’s no longer to generate the highest returns. For those who have more than they require, they could follow a conservative strategy with the portion dedicated to retirement and adopt an aggressive approach with the excess.
Prior to retirement, one must review the retirement checklist and ensure that they are ready to retire:
Retirement Investment Plan
Once you know what you own and how much you want from your retirement corpus it’s time to structure a retirement investment plan that can generate regular income.
Those with NPS investments can rely on a pension. Alternatively, retirees can purchase pension plans that provide a regular source of income through their retirement years.
Fixed Deposits & Bonds:
Retirees often prefer fixed deposits for regular income. With bank and corporate fixed deposits, quality matters more than returns. Investors should focus on the safety of capital rather than higher interest rates. They should also be aware of interest rate cycles and select an appropriate term for their deposits so that they avoid reinvestment risk.
Bonds require a significantly higher investment than deposits. They typically pay interest on an annual basis. Usually, investors should select bonds that they would be comfortable holding to maturity as the retail participation in bond markets is low.
Debt Mutual Funds:
Debt Mutual Funds are a newer investment option. They are fixed-income investments that offer better liquidity, tax efficiency, and returns. Unlike fixed deposits, the value of investments in a debt fund could change every day as the portfolio is marked to market. The two main risks in a debt fund are duration risk and credit risk.
Equity investments will help beat inflation in the long run even if they are volatile in the short-term. Through the mutual fund route, an investor gets the benefits of diversification, liquidity, and professional management. With individual shares, one must focus on high-quality long-term investments. For retirees, companies with a strong track record of dividends could supplement post-retirement income.