Why Union Budget 2017 Must Give the Nod to Target-Date Funds

In its February 2014 board meeting, market regulator SEBI alluded to “a long term product such as Mutual Fund Linked Retirement Plan (MFLRP)” as a part of its 'Long Term Policy for Mutual Funds in India'. Since then, some fund companies have launched their versions of retirement funds.

However, the regulator is yet to issue guidelines to pave the way for a defined MFLRP product. With Union Budget 2017 on the anvil, one hopes that the MFLRP segment is promulgated in the form of Target-Date Funds.

What are Target-Date Funds?

As the name suggests, target-date funds focus on a pre-set year of retirement. For instance, if you are 30 years of age, and intend to retire at the age of 60, then you will invest in a fund with a target date of 2047.

Target-Date funds are structured as fund-of-funds. They operate on the principle of asset allocation. In their initial years, target-date funds focus on wealth accumulation by largely investing in a combination of domestic and global equity funds. As the target-date approaches, the portfolio acquires a conservative bent with equity allocation being trimmed in favour of fixed income funds.

Simply put, a target-date fund can be a one-stop shop for accumulating a retirement kitty.

In the US, several billion dollars are invested in target-date funds. It certainly helps that target-date funds are often the default choice under defined contribution plans such as 401(K).

Retirement Planning and India

While awareness about retirement planning has grown over the last decade or so, it continues to be a bit of an alien concept for several Indians. Perhaps one can chalk it up to cultural factors. We have been a country of joint families wherein post-retirement, parents are provided for by their children. But thanks to a combination of factors such as growth of nuclear families, higher life expectancy, and cost of living, the need for retirement planning is real.

Successive governments have nudged citizens to independently provide for retirement as well: From opening up the National Pension System (NPS) for all citizens in 2009, enhancing its tax sops in Union Budget 2015, to launching the Atal Pension Yojana for those in the unorganised sector. The message is clear: Focus on retirement planning.

Tax Treatment and Benefits

The allure of tax benefits can be a strong motivator while making investment decisions. Let’s take the example of Equity Linked Savings Schemes (ELSS), a niche segment in the Indian mutual fund industry with assets of INR 501 bn (3% of industry assets) as on Dec 2016.

From Dec 2011 through Dec 2016, assets under ELSS have risen at an annualised rate of roughly 20%. That is no mean feat considering that the investments are subject to a three-year lock-in. To put things in perspective, over the same period, the broader category of other equity funds has grown by 25%.

So, what makes the niche ELSS category tick—tax benefits! Investments in ELSS are eligible for deductions under Section 80C of the Income Tax Act.

To enhance the appeal of target-date funds (and thereby facilitate retirement planning), it is pertinent that investments therein be made eligible for Section 80C deductions.

Another area which must be simultaneously addressed is the tax treatment of fund-of-funds. In India, fund-of-funds never took off. While the latter can be attributed to a variety of reasons, none is more significant than tax treatment.

Irrespective of their underlying investments (equity funds or fixed income funds), fund-of-funds are taxed akin to fixed income funds. Since the tax treatment for fixed income funds is more punitive (versus equity funds), fund-of-funds have been at a disadvantage.

Hence the need for regulatory intervention to ensure that target-date funds enjoy the same tax treatment as equity funds. And what better platform than the Union Budget to iron out these regulatory matters, and launch target-date funds on a strong footing.

How the Investor Wins

Presently while planning for retirement, investors can choose from NPS, small savings schemes (Public Provident Fund) and retirement plans of insurance companies. Target-date funds can effectively close the circle of retirement-focused avenues. 

The potential for ancillary benefits—inflow of long-term monies into mutual funds, greater influence of domestic institutional investors in markets, multiplier effect of higher consumption from retirees—is strong.

Hopefully, the Finance Minister will agree, and give the nod to target-date funds in Union Budget 2017.