Guaranteed returns for golden years? Go for annuities

Conservative investors and those in the lower tax bracket should opt for these, experts tell Sanjay Kumar Singh

The Insurance Regulatory and Development Authority of India (Irdai) recently asked the Life Insurance Corporation (LIC) to lower the return it offers on its immediate annuity plan, Jeevan Akshay.

The regulator wants the rate to be aligned with the 10-year government securities (G-sec) yield, which is currently at around 6.58 per cent. This news has brought annuities into focus.

Conservative investors, or those who don't use an advisor, may consider investing a part of their corpus in this product.

1. Deferred annuities

One option available to save for retirement is the pension plans of life insurers, also called deferred annuity plans.

You invest in them during your working life and then at the time of vesting (or maturity), two-third of the corpus has to be compulsorily invested in immediate annuities, which then pays out a pension.

Insurers' pension plans invest primarily in government securities, with a small portion of up to 25 per cent invested in equities to boost returns.

Most plans offer a return that is 50-100 basis points lower than the G-sec return.

"Pension plans of insurers provide capital guarantee. Also, every year a bonus is declared that gets locked in and is also guaranteed thereafter," says RM Vishakha, managing director and CEO, IndiaFirst Life Insurance.

If your corpus is worth Rs 100 and the bonus declared is Rs 5 at the end of a year, the corpus goes to Rs 105. It can't decline to a lower level thereafter.

Two-third of the corpus accumulated in an insurer's pension plan has to be compulsorily annuitised. This can pose a problem if the annuity rates are low at the time of vesting.

2. NPS is an alternative

Another deferred annuity plan available is the National Pension System (NPS).

"We prefer the NPS over insurers' pension plans. The Section 80C benefit gets exhausted by other products. If you want tax benefits also from your retirement savings, then NPS is better as it enjoys an extra tax deduction under Section 80CCD(1B)," says Arvind Rao, financial planner and founder, Arvind Rao & Associates.

Given the long investment horizon available, investors with the necessary risk appetite may also opt for equity mutual funds for accumulation.

On the fixed-income side, there are options like Employees Provident Fund (8.65 per cent tax free), Public Provident Fund (7.8 per cent tax free), and so on.

3. Immediate annuities

If you have invested in an insurer's pension plan, 67 per cent of the corpus has to be compulsorily used to buy an annuity, also called an immediate annuity (the corresponding number for NPS is 40 per cent).

While compulsory annuitisation is often viewed negatively, it ensures that you use the money to generate a pension for old age. Those who have accumulated a corpus using other products can also buy an annuity.

The returns from an annuity are guaranteed at the time of purchase. The current rates are in the range of 5.5 and 7.3 per cent.

Rates vary depending on your age, the annuity option, and rates prevailing in the economy.

Annuities protect you against the risk of interest rates declining in the future.

"Today the rates offered by annuities may appear low. But over 20 years, as the economy advances, interest rates may decline further, in which case these rates will appear attractive," says Anil Rego, CEO, Right Horizons.

All other fixed-income products are subject to reinvestment risk -- the risk of having to invest at a lower rate if interest rates fall. But not all experts believe that interest rates will witness a secular decline.

They think that rates tend to be cyclical and can rise in the future, so buying annuities at today's rates doesn't make sense.

The payouts from an annuity get taxed at the marginal tax rate, a problem for those in the higher tax brackets.

"In case of annuities, the entire payout is taxed. In many fixed-income products, only the interest component gets taxed," says Rego.

Another potential disadvantage is that you don't have access to your principal during your lifetime (the principal gets returned in some plans on death or end of plan).

According to Rego, allocation to immediate annuities can range from 0-33 per cent of a person's retirement corpus.

A person in the higher tax brackets may allocate less or zero to them, while a person with a low-risk appetite, who is keen to have certainty of post-retirement income, may allocate more.

Many options are available within immediate annuities.

You can choose to receive annuity for your own lifetime, have the same or 50 per cent paid to your spouse, or choose the return of purchase price option, in which case the principal will be paid to your nominee.

The rate of payout is lower in this option compared to one where there is no return of purchase price. "One should essentially look to guarantee an adequate pension for lifetime for yourself and your spouse," says Santosh Agarwal, head of life insurance, Policybazaar.com. Choose an option that suits your circumstances.

4. Other options for retirees

Those in the higher tax brackets may invest in tax-free bonds after retirement. Other options include Senior Citizens Savings Scheme (8.3 per cent taxable return), Pradhan Mantri Vaya Vandana Yojana (8.3 per cent taxable return), Post Office Monthly Income Scheme (7.5 per cent return, taxable), bank fixed deposits (6.5-7.5 per cent) and monthly income plans (MIPs) of debt funds.

"Savvy investors can opt for the systematic withdrawal plans (SWP) of mutual funds with around 80 per cent in debt and 20 per cent in equities," says Rego.