Buying a pension plan? Don't before you relook at your options -- at least during the accumulation phase when a pension policy does not offer as attractive a return or as good a tax break as other investment plans around.

Take the case of Mohan Ray. He bought a pension plan from ICICI [Get Quote] Prudential Life Insurance three years back.

As he was 35 years old then, he was asked to invest Rs 45,000 annually so that he could retire on a monthly pension of Rs 12,000 when he turned 60.

Being a financial analyst, Mohan decided it was wiser to put in Rs 10,000 in the pension plan, avail of the Section 80 CCC tax break, and invest the balance in an endowment unit-linked plan.

All insurance plans fall under Section 88 of the Income Tax Act, whereby the policyholder can avail of a tax rebate for a maximum investment of Rs 70,000. He also gets another Rs 10,000 exemption if he avails of the pension plan.

But then, the Section 80 CCC limits the exemption to Rs 10,000. This is despite the insurance industry persistently pushing for a four-fold rise in the tax break to Rs 40,000.

What's more germane, however, is how the proceeds under pension and other insurance plans are treated at the time of maturity.

Under pension plans, an individual is forced to buy an annuity product when he retires. The maximum he can withdraw from the accumulated funds upon retirement is 33.33 per cent. From the balance, he has to purchase an annuity product from any insurance company, though not necessarily the one he invested in during the accumulation phase.

In the unfortunate event the pension policy holder dying prior to retirement or deciding against buying an annuity plan at the end of the term for personal reasons, he or his beneficiary can withdraw the entire proceeds, but would have to pay a tax on the same as prevailing then.

At the current level of income tax at the highest rate of 30 per cent plus the 2 per cent education cess, this would mean the individual would get back less than 69 per cent of his total proceeds.

Compare this scenario with an endowment plan, where maturity proceeds fall under Section 10(10D). The entire proceeds are tax free.

This means should a policyholder put in Rs 40,000 each year in an endowment plan, at the end of the term, he would be able to avail of Section 88 tax rebate on the annual investments, plus, more importantly, the proceeds are tax free under Section 10(10D).

Mohan today feels he has been wise in taking such a decision. On the one hand, he has reduced his taxable income, and on the other hand, the net asset value on both plans is more or less similar.

As on December 31, 2004, the NAV on ICICI Prudential's Endowment Maximiser stood at 17.44 per cent, while the NAV on the Pension Maximiser stood at 17.97 per cent.

"The main benefit of the pension plans is that once bought they force the individuals to save regularly for the later part of their lives. Compared with other savings instruments, pension plans do not allow individuals access to the entire amount at the end of the accumulation phase. This can only be availed of periodically, by way of annuities," said Mukul Gupta, chief financial officer, Bajaj Allianz Life.

This mechanism thus ensures that the individual has periodic cash flows during his retirement, akin to a salary during his working days. Otherwise, in all likelihood, a lump sum could be consumed immediately.

Agreed, today insurance companies are pushing customers not to purchase insurance solely for the sake of the tax breaks.

But when one can be more proactive and get the best of both worlds, why not?

What's more, while insurance companies do not offer medical riders under pension plans, they do so under other insurance covers.

This means, an individual can get a further tax break under Section 80D by purchasing a medical or critical illness rider.

Insurance companies, however, admit that their agents are more shrewd and that explains why the average premium on insurance plans has shot up to Rs 50,000-65,000, while that on pension covers remains stagnant at Rs 10,000. Plan well, what have you got to lose?

The pros and cons

• Pension plans offer limited tax sops capped at Rs 10,000
• Maturity proceeds can be taxed if individual fails to buy an annuity product
• Any investment -- PF, PPF, postal savings or mutual funds -- offer better tax breaks and are ideal accumulation vehicles
• Pension plans are a safety net for individual's retirement since India does not offer a social security net