Everybody wants a steady income in their retirement years to lead a comfortable and stress-free life. An annuity pension plan is one such solution that is often recommended for retirees. Is it really a good investment?
What are annuities?
Annuities are contracts between you and an insurer in which you make lump sum or regular investments and in return receive regular payouts, beginning either immediately or in the future. These payments could be monthly, quarterly, bi-annual or yearly based on your preference.
Fundamentally, annuities take care of longevity and reinvestment risk for their investors as they get paid annuities throughout their life term (or for a fixed term).
There are two types of annuities.
- In Immediate annuities, payouts start immediately. They are usually preferred by those who have already retired and have a lump sum money to invest.
- Deferred annuities in turn are for those relatively younger – say in their 40s or 50s and would like annuities to start later in their life.
You need to consider a couple of factors before buying annuities:
What does the growth in annuity plans look like?
Annuity returns vary based on your age, the type of annuity chosen and the existing interest rate scenario in the economy.
For instance, if a 60-year old is making a lump sum payment of Rs 15 lakh and seeks a constant annuity throughout his life and without return of purchase price, he will get an annuity of Rs 1.15 lakh or a simple annual return of 7.7% annually. Annuity rates are slightly higher for higher investment amounts.
Return will increase to 10% p.a. for a 70-year old and 14.8% for an 80-year old (See table). Annuities are priced based on the mortality tables and chances of death; therefore usually payouts increase with age, especially for annuities where the purchase price is not to be returned to family members on investor’s death.
However, if one looks at annuity rates with the return of premium, the yields are very low – 5.2-5.3% p.a. At such low rates, it hardly beats inflation and only erodes retirement wealth. Opting for an annual increase in annuity payments to cover inflation further reduces the annuity/annuity yields for investors.
Income earned in the form of annuities is taxable at the income tax slab rate. While the income can be expected to be relatively lower after retirement, taxes, if any, also reduce its post-tax lucrativeness.
Income above Rs 3 lakh /year is taxable for senior citizens, while it is above Rs 5 lakh for super senior citizens (80 years plus).
Once you have invested in an annuity plan, the initial investment can be withdrawn only on diagnosis of specified critical illnesses or disability or death.
What investors should do?
An annuity is suitable for only a select profile of investors. For instance, investors in their 70s can expect to earn 10% annually (see table) for single life policies without return of purchase price.
It comes out better than all fixed investment products in the country available for senior citizens. However, one should know that in such circumstances, spouse or family members will not get any money on the investor’s death.
What are your Alternatives?
Interest rates have fallen over the last two decades. As India becomes more developed, its interest rates are expected to be even lower in the future which in turn would further reduce the annuity rates.
Most investors are therefore better off managing their retirement income by way of a Systematic Withdrawal Plan (after retirement) and with a dash of equities.
For instance, an Rs 15 lakh portfolio after retirement, investing in a mix of equity and debt (that yields 8% per annum) could last for about 28 years. This is 8 more years than in a debt only portfolio. We are assuming an annuity of Rs 10,609 per month in both cases.
By using the SWP, you not only keep the option to tweak annuities based on your requirements but also have access to capital (along with your family) in case of contingencies.
An Annuity pension covers longevity risk but suffers from poor return rates that hardly keep up with inflation. A mixed equity-debt portfolio is a better way to provide retirement income for your sunset years.
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