Fear reinvestment risk? Go for immediate annuities instead, say experts

Only they can secure against the possibility of lower interest rates over long term

The Life Insurance Corporation (LIC) of India recently revised the annual pension on its immediate annuity plan, Jeevan Akshay VII, upward. A person aged 60 will now get a return of 8.49 per cent in the without-return of purchase price (RoPP) variant and 5.99 per cent in the with-RoPP variant.

A change of rate by the industry’s largest player assumes significance. LIC’s assets under management in the pension, general annuity, and group fund category stood at Rs 9.12 trillion, compared with Rs 1.3 trillion for all private players (Source: Insurance Regulatory and Development Authority of India's annual report, 2020-21).

Lock in rate for life

Interest rates on fixed-income products have been declining over the long term.

“State Bank of India one-year fixed deposit (FD) gave 8.25 per cent in May 2015 and gives 5.1 per cent today,” says Vivek Jain, business unit head–investments, PolicyBazaar.

This trend creates reinvestment risk: when a person goes to reinvest the corpus from a product that has matured, he could be forced to do so at a lower rate. An annuity allows an investor to lock in the rate of interest for his lifetime.

“It offers protection against longevity risk – the risk that you may outlive your savings,” says Jain.

Other fixed-income products allow you to lock in the rate for a limited period.

“Senior Citizen Savings Scheme (SCSS) allows you to lock in the rate for five years, FDs for up to 10 years, and Pradhan Mantri Vaya Vandana Yojana (PMVVY) for 10 years. With long-term government bonds, you can lock in the rate for up to 30 years,” says Deepesh Raghaw, founder, PersonalFinancePlan, a Securities and Exchange Board of India-registered investment advisor.

Useful in many scenarios

An elderly person may worry that his family members will not be able to manage his wealth in his absence. Or may fear his children may not look after his spouse in his absence. Parents worry about the well-being of specially-abled children.

“All these people can ensure a constant income stream for their dependants’ entire lifespan through an annuity,” says Raghaw.

Low return, low liquidity  

The rate of interest on immediate annuities is not attractive, especially in the with-RoPP variant, compared to products like SCSS and PMVVY, which offer 7.4 per cent. Returns from annuities also tend to be low when bought at a younger age.

Their returns are also not inflation-protected. The value of the amount they pay erodes over time.

Liquidity poses another challenge.

“If you want your investment back, the surrender value will typically be 75-80 per cent,” says Jain.

Keep part of corpus in liquid instruments

Investors can earn a better rate of return from an immediate annuity by staggering their purchases.

“Buy in tranches at 60, 65, 70, and so on. The rate of return improves a lot with age, especially in the without-RoPP variant,” says Raghaw.

Weigh the pros and cons of the without- and the with-RoPP variant. The former gives a higher return. “You have to invest a smaller amount to get the desired pension. The money thus freed up can be used for other purposes,” says Raghaw.

According to Naval Goel, chief executive officer, PolicyX.com, “Those who don’t have dependants and desire a higher return may opt for this variant.”

Those who want to pass on wealth to their heirs may prefer the with-RoPP option.

“One risk in the without-RoPP variant is that the invested amount goes completely waste in case of early death,” says Jain.

Check the surrender value, which varies across insurers.

“The standard product, Saral Pension, with a surrender value of 95 per cent, scores in this regard,” says Jain.

Owing to the low liquidity in immediate annuities, retirees must keep a considerable portion of their retirement corpus in more liquid instruments.

Finally, compare rates.

“But since these are very long-term products, stick to one of the bigger and stronger brands,” says Goel.