Sep 022015
 

Interest Rate in APY

There is quite some buzz in market about the interest earnings of the contributions made towards the Atal Pension Yojana. While the APY is definitely a meaningful scheme for those who are from unorganized sector, the real bummer comes in when one looks at APY from the perspective of interest earnings.

Interest Rate in APY

Interest calculation on APY

Let us explain this with a quick mathematical illustration, which will in turn be based on a few assumptions. Let us begin with the assumptions:

  • You are of age 30.
  • You select the pension slab of ₹ 5,000 per month after retirement.

According to the scheme, if the above assumptions are true then,

  • Your monthly contribution has to be ₹ 577.
  • You need to pay this amount for 30 years straight.

At 8% market interest rate per year, the amount of money that is required to pay a pension amount of ₹ 5,000 per month is ₹ 7,50,000.

Here is the simple calculation:

Therefore, monthly interest earned will be:

This monthly interest is actually paid out as pension.

Now based on above assumptions, you will be paying ₹ 577 per month and earn a pension of ₹ 5,000 per month after paying for 30 years.

The total payment you actually make in 30 years will be:

That amount is way shorter that the amount required for the target pension amount. So, to reach the corpus of ₹ 7,50,000, your money will be put to work and interest will be accumulated. The accumulated interest will keep growing every year to eventually reach the target amount of ₹ 7,50,000. How much interest is required? Let us find out!

Year 1

Assuming that the annual interest rate is 7.37%, the total interest you earn in a single year is:

So, total money in your account after 1 year:

Year 2

You had 7430.83, you pay another 6924. So, the total interest you earn at the end of 2nd year will be:

So, total money in account at the end of 2 years will be:

Thus, your account money keeps growing at a compounded rate.

So, the total money in your account after 30 years of payment using the compound rate formula

will be:

YearBalance at end of yearNew deposit in a yearBalance for calculating interestInterest EarnedNew Balance after interest
1692406924510.29887434.2988
27434.2988692414358.29881058.20662215416.50542
315416.50542692422340.505421646.4952523987.00067
423987.00067692430911.000672278.14074933189.14142
533189.14142692440113.141422956.33852343069.47994
643069.47994692449993.479943684.51947253677.99942
753677.99942692460601.999424466.36735765068.36677
865068.36677692471992.366775305.83743177298.2042
977298.2042692484222.20426207.1764590429.38065
1090429.38065692497353.380657174.944154104528.3248
11104528.32486924111452.32488214.036338119666.3611
12119666.36116924126590.36119329.709616135920.0708
13135920.07086924142844.070810527.60802153371.6788
14153371.67886924160295.678811813.79153172109.4703
15172109.47036924179033.470313194.76676192228.2371
16192228.23716924199152.237114677.51987213829.7569
17213829.75696924220753.756916269.55189237023.3088
18237023.30886924243947.308817978.91666261926.2255
19261926.22556924268850.225519814.26162288664.4871
20288664.48716924295588.487121784.8715317373.3586
21317373.35866924324297.358623900.71533348198.0739
22348198.07396924355122.073926172.49685381294.5708
23381294.57086924388218.570828611.70867416830.2794
24416830.27946924423754.279431230.69039454984.9698
25454984.96986924461908.969834042.69108495951.6609
26495951.66096924502875.660937061.93621539937.5971
27539937.59716924546861.597140303.69971587165.2968
28587165.29686924594089.296843784.38118637873.678
29637873.6786924644797.67847521.58887692319.2669
30692319.26696924699243.266951534.22877750777.4956

PLEASE NOTE: ABOVE CALCULATIONS ARE ROUGH ESTIMATES AND THERE MAY BE ERRORS. THE CALCULATIONS ARE USED FOR THE PURPOSE OF EXAMPLE ONLY AND DO NOT INDICATE FINAL CALCULATIONS MADE BY GOVERNMENT.

So essentially, under Atal Pension Yojana, you will be paid an annual interest rate of 7.37% per year for achieving a corpus of ₹7.50 lakhs with monthly contribution of ₹577 for 30 years to earn a pension of 5,000 per month.

This interest rate is lower than the current interest rate the banks provide for Fixed Deposits. The current market rate is 8 to 8.5%. Using the above example when we calculate interest for different entry age and deposit period, the interest rate is always lower than current market rate. APY interest rates vary between 6.92% and 7.53% for the pension slab of ₹ 5,000. There may be slight variations for other slabs.

Funny that the above calculations did not account for inflation. Market interest rate grows with year-on-year inflation! Thus, instead of paying for APY, one can opt for fixed deposits.

However, what really makes sense is that the payments under APY are made each month, whereas for FD, you will have to pay the whole deposit amount at once! This is not possible for everyone.

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