Retirement is a delicate time. You dont need to bother about making money, yet you want to have enough for a comfortable life ahead. In the absence of a pension, or an insufficient pension, your need is a financial instrument that gives you the income you seek. Month after month. Year after year. And for the rest of your life.
Annuity is a scheme in which after paying a Lumpsum amount the person gets guaranteed fixed monthly / quarterly / half yearly /yearly throughout the life. They have very important role as it is being used by most of the organization for paying Pensions.
These structured financial instruments are called annuities. But they are still a work-in-progress, both with those who need it and those who offer it. In the absence of an organised pension framework for non-government employees, the retirement planning is scattered across many investment options, rather than being consolidated, which would make buying annuities a natural progression.
Moreover, several life insurers offer annuities, but they have average returns and poor flexibility. Ultimately, the Pensions Bill will be passed, and offer structured retirement planning options. Likewise, insurers, most of whom are still grappling with the nuances of annuities, will start tailoring their products better to your needs and expectations. For now, here’s a primer on what’s available in the annuities space and, if you have a lump sum and are looking for monthly income for life, what you should opt for.
Moreover, several life insurers offer annuities, but they have average returns and poor flexibility. Ultimately, the Pensions Bill will be passed, and offer structured retirement planning options. Likewise, insurers, most of whom are still grappling with the nuances of annuities, will start tailoring their products better to your needs and expectations. For now, here’s a primer on what’s available in the annuities space and, if you have a lump sum and are looking for monthly income for life, what you should opt for.
Depending on when you buy, annuities can be divided into two types, deferred and immediate. A deferred annuity requires you to first build a corpus, which you then use to buy an annuity. Most insurers enable the ‘building’ bit through pension plans.
When the tenure of pension plan ends,varying from 3-25 years, you use the money accumulated to buy an annuity. For unit-linked pension plans, one has to stay invested for at least three years. Whereas, in traditional policies, one can buy an annuity after two years.” Also the maturity amount is tax-free, though accompanied by several other conditions. You have to use at least two-thirds of the maturity amount to buy an annuity; you can do whatever you want to with the remaining one-third. In an immediate annuity,an annuity can be bought for a lump sum. Of the 16 life insurers, only four presently offer immediate annuities: Bajaj Allianz Life, HDFC Standard Life, ICICI Prudential Life and LIC. Even in a deferred annuity, on maturity, you can switch insurers. An immediate annuity can be bouhgt from another insurer without any extra cost.
Types of payouts
In totality there are six kinds of annuity payout options, with the operative differences revolving around three factors: how long will the annuity continue, how much money you will get every month and what happens to the corpus on your death. And in purview with these factors, the current bunch of plans are classified into four:
Life annuity without return of purchase price. Gives you monthly income for life, but keeps the principal (the purchase price) on your death. This is suited for you if you live alone with no spouse and don’t want to pass on the annuity amount to your heirs.
Annuity Guaranteed for certain periods: The annuity is paid to the life assured for periods of 5 or 10 or 15 or 20 years as chosen by him/her, whether or not he/she survives that period. After the chosen period, the annuity is paid to the life assured as long as he/she is alive.
Life annuity with return of purchase price. The annuity is paid to the life assured as long as he/she is alive. On the death of the life assured, the purchase price of the annuity is paid as death benefit. The purchase price includes the Sum Assured under the Basic Plan, the accrued Guaranteed Additions and any accrued bonuses, excluding the commuted value, if any.. This is suited for you if you want to leave something behind for your spouse or heirs.
Dependent spouse plans. There are two options here. One, even on your death early in the tenure, the insurer pays your spouse for a certain number of years. Two, on your death, it pays your spouse for life. If you have a dependant spouse, you should be looking at such joint plans.
Inflation-adjusted plans. The monthly payout increases each year by a pre-determined amount, but the rate of return is low.
The best noted thing about annuity is that the rate of return stated by the insurer is assured and fixed. Once a plan gets selected, one gets committed to it for life time.Though the rate of return may vary from plan to plan and from insurer to insurer. How much money one receives every month will depend on one's age, and how long and how much the insurer is committing to pay.
Unlike insurance policies, the risk for an insurer here is longevity. The longer you live, the longer it will have to pay or in other words the younger you are, the lower the rate you will get. For instance, SBI Life, on its lifetime annuity, gives 5.3 per cent to a 50-year-old, 6.7 per cent to a 60-year and 9.5 per cent to a 70-year-old. These payouts are taxable in your hand.
Alternative options
Basically, annuities are useful in mature markets, but not so much in developing markets. 60-year-old is still looking at 20-25 years, for which, he needs an instrument that keeps pace with inflation.
Currently the lifetime annuity plans offering 8-9 per cent a year are those that don’t return the purchase price. The ones that do return the purchase price offer only 3.5-7 per cent a year — way less than even the risk-free rate. Returns on annuities haven’t been that attractive yet.
By comparison, a five-year bank deposit, which also offers a tax break on investment under section 80C, today offers 8 per cent. Other assured monthly income options like the Senior Citizens’ Savings Scheme (SCSS) offers 9 per cent and the post office monthly income scheme (POMIS) 8 per cent. The difference is that their tenures range from six years (POMIS) to eight years (SCSS), the annuity rate is for life. Then, there are investment caps on SCSS (Rs 15 lakh) and POMIS (Rs 3 lakh), there are no such caps on annuities and they also save you from doing the dirty work.
Still, according to the consequent discount on market rates that annuities currently offer, financial planners advise to ignore them and wait till the gap narrows. Experts say that if one is at 60, one must maximise the investment in the SCSS, POMIS, and bank FDs; after that, if the monthly income needs are met, equities should be looked upto. A 70-year-old, though, can look at annuities.
As the market grows and matures, as an organised framework develops for pensions, returns from annuity plans are likely to align closer to market rates and the plans are likely to become more flexible. For now, only if you are fine with the lower rate and comfortable with the rigidity should you rely on annuity plans to fund your retirement. If you are not, do it yourself.
Deferred annuity plans
You need to stay invested for at least two years in traditional products and three years in unit-linked plans to be eligible for an annuity. Annuities give periodic payments that can be chosen on periodicity like monthly, quarterly or yearly.
Mid-course changes
Policyholders can choose an annuity within three to six months of maturity. There are various options and an option once chosen cannot be changed. Likewise, an annuity is a lifetime contract — the annuitant doesn’t have the option to terminate the payout or end the contract.
How rates are decided
On contrary to the life insurance policy, where the risk borne is that of a policyholder dying, the risk borne in an annuity is the risk of the annuitant living too long. So, the younger a person, the lower the payout. Also, the monthly payout will depend on the kind of annuity you choose: a lifetime annuity without a return of purchase price pays more than a lifetime annuity with a return of purchase price.
Immediate annuities
Annuitant has to take a pension plan and then buy an annuity with the maturity proceeds. However, he can buy an immediate annuity from another insurer with at least two-thirds of the amount, if not the entire sum.
