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:

Year Balance at end of year New deposit in a year Balance for calculating interest Interest Earned New Balance after interest
1 6924 0 6924 510.2988 7434.2988
2 7434.2988 6924 14358.2988 1058.206622 15416.50542
3 15416.50542 6924 22340.50542 1646.49525 23987.00067
4 23987.00067 6924 30911.00067 2278.140749 33189.14142
5 33189.14142 6924 40113.14142 2956.338523 43069.47994
6 43069.47994 6924 49993.47994 3684.519472 53677.99942
7 53677.99942 6924 60601.99942 4466.367357 65068.36677
8 65068.36677 6924 71992.36677 5305.837431 77298.2042
9 77298.2042 6924 84222.2042 6207.17645 90429.38065
10 90429.38065 6924 97353.38065 7174.944154 104528.3248
11 104528.3248 6924 111452.3248 8214.036338 119666.3611
12 119666.3611 6924 126590.3611 9329.709616 135920.0708
13 135920.0708 6924 142844.0708 10527.60802 153371.6788
14 153371.6788 6924 160295.6788 11813.79153 172109.4703
15 172109.4703 6924 179033.4703 13194.76676 192228.2371
16 192228.2371 6924 199152.2371 14677.51987 213829.7569
17 213829.7569 6924 220753.7569 16269.55189 237023.3088
18 237023.3088 6924 243947.3088 17978.91666 261926.2255
19 261926.2255 6924 268850.2255 19814.26162 288664.4871
20 288664.4871 6924 295588.4871 21784.8715 317373.3586
21 317373.3586 6924 324297.3586 23900.71533 348198.0739
22 348198.0739 6924 355122.0739 26172.49685 381294.5708
23 381294.5708 6924 388218.5708 28611.70867 416830.2794
24 416830.2794 6924 423754.2794 31230.69039 454984.9698
25 454984.9698 6924 461908.9698 34042.69108 495951.6609
26 495951.6609 6924 502875.6609 37061.93621 539937.5971
27 539937.5971 6924 546861.5971 40303.69971 587165.2968
28 587165.2968 6924 594089.2968 43784.38118 637873.678
29 637873.678 6924 644797.678 47521.58887 692319.2669
30 692319.2669 6924 699243.2669 51534.22877 750777.4956

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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