Does an Annuity Plan Work for You?

You work hard to build a retirement fund. The only task left for living a comfortable life after retirement is to get regular income out of this. A safe way of doing that is to buy annuity plans, which invest your money in markets and pay you regularly from the returns generated. Many life insurance companies offer these plans. Investors in the National Pension System (NPS) and superannuation funds have to mandatorily buy annuity. Annuity plans come in different forms.

Deferred or Immediate: There are two basic plans - deferred and immediate. In deferred annuity, you deposit a lump sum and wait for it to grow; you can also regularly save over a period, after which regular income starts. In immediate annuity, payments start immediately. "Immediate products are for the 60 years old segment, while deferred products are suitable for customers in the age bracket of 50-60 years," says Puneet Nanda, Deputy Managing Director, ICICI Prudential Life Insurance.

Guaranteed income for life: The best thing about annuity plans is certainty of regular income. The rate set at the time of purchase does not change during the payment period. "One of the biggest advantages of annuities is that they eliminate reinvestment risk. In fixed rate annuities, the risk that the interest rate will be lower when one reinvests the principal is eradicated. Products such as fixed deposits or debt mutual funds or post office monthly income scheme carry reinvestment risk. Annuities guarantee the same payout rate for life," says Tarun Birani, Founder and CEO, TBNG Capital Advisors.

However, this guarantee comes at a price. The rate of return is usually lower than what is offered by the other safe debt products. "The annuity provider takes the risk of promising you a fixed amount in any market scenario. The returns provided by annuities have not been attractive. Thus, if you expect good returns, annuity is not for you, but if you want some security for a rainy day, you should opt for these plans," says Birani.

Single or Joint: In single life plans, only one individual is paid, which means that after death, no payment is made to the person financially dependent on him or her. On the other hand, in joint life annuity, after the death of the first annuitant, the second one continues to receive the money. The plan stops after the death of the second annuitant. "Single life annuity suits those who do not have a dependent, while joint life annuity should be chosen by those whose family members will be dependent on their income," says Naveen Kukreja, CEO and Co-founder, Paisabazaar.com.

Purchase Price Return Option: In this, the amount spent to buy the plan is returned to the nominee after the death of the annuitant. It is available on both single life and joint life annuities. In joint life annuity with the return of purchase price option, pension continues throughout the life of both the annuitants, and the corpus is given to the nominee after the death of the second annuitant. "A lot of customers go for this option as they want to leave a legacy for their spouse or children. We provide a range of options for the amount that is returned," says Nanda of ICICI Prudential Life Insurance. The higher the amount you get back, the lower is your pension.

"The life annuity option gives a tad higher rate (approximately 1 per cent more) than life annuity with return of purchase price option, but no corpus is returned on death," says Vibha Padalkar, MD & CEO, HDFC Life Insurance. So, if you find that the annuity income is not sufficient in the return of purchase price option, go for life option without return of purchase price. "It is more suitable for those who maintain a healthy lifestyle and believe they will live long enough to get higher income while they are alive. It is also appropriate for those who have other means to leave a legacy," says Padalkar.

Guaranteed fixed term payout and then lifelong payout: One option gives guaranteed income for a defined number of years, 10, 15, 20, and lifelong thereafter. "Under the plan without the return of purchase price option, in case of early demise of the annuitant (say within 15 years or so), the total annuity amount received will be well below the purchase price. In order to avoid such a scenario, the annuity without return of purchase price has this variant," says Padalkar of HDFC Life Insurance.

So, who should go for such a plan? "This option is appropriate for those who have financially dependent family members and want a higher stream of income than what the return of purchase price option offers. This covers loss of capital in case of early demise of the annuitant in the without return of purchase price option," adds Padalkar.

You may look for this option if you have a fixed recurring liability for a certain period like a loan or want to support studies of your grandchild. "Customers who have a fixed liability, like an outstanding home loan, prefer guaranteed income for a fixed time period, say for 15 years, irrespective of whether they are around. This can provide income to pay home loan instalments and provide financial security to families. If customers survive this guarantee period, they will continue to get an income," says Nanda of ICICI Prudential Life Insurance.

Growing Annuity Plan: The regular income you receive at the age of 60 may not be sufficient after five years due to inflation. There is an annuity option where payouts grow annually, typically by a fixed amount. "Under this, annuities increase by a certain percentage (say 5 per cent every year) for as long as the person is alive. To an extent, this protects your income from rising prices and ensures that the payouts are adjusted each year in line with inflation," says Padalkar of HDFC Life Insurance. "However, the drawback is that the amount starts at a much lower level (than a flat annuity) to allow for later increases," she adds.

Annuity in NPS

In NPS, once you reach the vesting age, you get the option to buy an annuity plan from Annuity Service Provider (ASP) appointed by PFRDA. ASPs are responsible for regular monthly payments. At present, there are five ASPs, as per the NSDL website. These are Life Insurance Corporation of India, SBI Life Insurance, ICICI Prudential Life Insurance, HDFC Standard Life Insurance and Star Union Dai-ichi Life Insurance. If you do not take a decision at the vesting age, your corpus goes into a default annuity scheme which is joint life with return of purchase price (provides annuity for life to the subscriber and his/her spouse with a provision for return of the purchase price).

To decide which service provider is better for you, compare the returns or monthly payments they are offering on the NSDL website https://cra-nsdl.com/CRAOnline/aspQuote.html, by entering your personal details. Once you select the ASP, check further details about the features of the products. "There are additional benefits and features which need to be considered such as safety, liquidity, partial withdrawal, characteristics and returns. It is also essential to understand all fees and expenses. The terms and conditions of the contract must be comprehended before purchase," says Birani of TBNG Capital Advisors. Many ASPs also offer discounts to NPS subscribers. For instance, ICICI Prudential Life gives a 0.5 per cent discount on the annuity purchase price if you are an NPS subscriber.

The Tax Angle

There is no tax advantage on annuity income. "The payouts are taxable as per the tax slab of the person. Hence, post-tax returns barely beat inflation rates, especially for those in the highest tax bracket," says Kukreja of Paisabazaar.com. So, if you are in the higher income tax bracket, keep your exposure limited.

Lack of Liquidity

Annuities are not very liquid investments. If you have opted for immediate annuity under life option with return of purchase price, you can surrender the policy and get the money back after paying a fee. However, in life option with no return of purchase price, there is no exit route under usual circumstances. "Annuity providers usually do not allow premature surrender. Once an investor buys an annuity plan, he cannot access his principal for unforeseen financial exigencies. Thus, investors should plan their exposure to annuities after building an emergency fund and accounting for various short- and long-term financial goals," says Kukreja.

It is not prudent to keep your entire corpus in annuity plans as most do not offer any exit. Keep your exposure limited to ensure a decent guaranteed income and also have some readily accessible fund to meet exigencies. "The retirement corpus has two goals: to provide regular income and to make sure you stay ahead of inflation. Thus, it is advisable to put a portion of your retirement fund into inflation beating investments. I would recommend that one should invest at least 20 per cent corpus in an inflation-beating asset such as equities," says Birani of TBNG Capital Advisors.

@naveenkumar