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Annuity plans take care of longevity risk, but their rate of return is low

The key attraction of an annuity is the promise of a fixed and regular income after retirement

annuity
Sarbajeet K Sen
3 min read Last Updated : Aug 09 2019 | 12:10 AM IST
Those looking for regular and guaranteed income during retirement often invest in annuity plans offered by insurance companies. However, these plans may not quite live up to their promise of ensuring financial security in old age. 
Annuity plans are of two types — immediate and deferred. In an immediate annuity plan, the pension starts as soon as the money is invested. A deferred annuity, on the other hand, has two phases — an accumulation phase where the premium gets invested, and an income phase in which the accumulated corpus is used to buy an immediate annuity plan. 

The key attraction of an annuity is the promise of a fixed and regular income after retirement. “An annuity provides the assurance that you will receive a fixed amount of money each month from the time you retire till the rest of your life. The insurer takes the risk of ensuring your money lasts as long as you live. Annuity plans, including deferred annuity plans, also help you lock your interest rate, eliminating reinvestment risk in a falling interest-rate environment,” says Mahavir Chopra, director-health, life and strategic initiatives, Coverfox.com.

In the post-retirement phase, investo~turn risk-averse and look for a regular income flow that does not fluctuate from one month to another. Market-linked products, such as mutual funds (MFs) and Ulips, cannot offer a guaranteed return. “Annuity plans guarantee a certain percentage of return. There is also no risk of losing the capital. All this provides a sense of security to the investor,” says Amar Pandit, founder, Happyness Factory.

The insurance cover adds to the element of safety. “A deferred annuity offe~insurance protection, which works in its favour,” says Naval Goel, chief executive officer, PolicyX.com.


However, a major point on which annuity plans falter is return. Since annuities bear longevity risk (the risk that the investor may outlive the expected lifespan), they provide conservative returns. These returns may not be able to beat inflation. “Annuity plans deliver low rates of return — between 6-7 per cent per annum — which may not be enough to provide for your retirement needs. Assuming that a retiree invests his entire retirement corpus in an annuity plan that gives an annual return of 6 per cent, he may find it difficult to survive on this money throughout his lifetime,” says Pandit.

Chopra adds that the impact of inflation makes the product unattractive. “The sum that you get every month as annuity is fixed and is not inflation-proof. A simple calculation says that if you need Rs 15,000 to meet your monthly expenses today, you are likely to need Rs 30,000 after 15 years, at a modest inflation rate of 5 per cent,” he points out.

Another issue in annuity plans is their lack of liquidity. Unlike MFs or fixed deposits, annuity-based pension plans do not provide the flexibility to withdraw money in case of an emergency. “Lack of liquidity makes annuity plans a less preferred product, compared to other savings instruments,” says Goel.

Many financial adviso~do not see much value in annuity plans. “These plans are not in the investor’s best interest. Other better options are available for structuring the income payout,” says Pandit. Investo~should at best invest only a limited portion of their retirement corpus in annuities to ensure a base, regular income and to avoid reinvestment risk.

Topics :InsuranceInvestmentretirementsavings