Govt bonds and immediate annuity plans: 2 options for retirement income

The first offers a guaranteed rate of return for long; the other secures income for the rest of your life

If you have retired recently, you are probably on the lookout for low-risk investment options that give a regular income. There is the tried-and-tested bank fixed deposit. Two other low-risk products that come to mind are government bonds and immediate annuity plans by insurance companies.

With interest rates on the upswing, rates of return on government bonds have turned attractive. Retail investors can purchase them either through the RBI Retail Direct platform or through their brokers. Alternatively, they can buy an immediate annuity plan from an insurance company. Here, the buyer invests a lump sum amount after which the insurance company provides a guaranteed income for life.

Two options

Government bonds allow investors to lock in the rate of interest for the tenure of the bond. Their maximum tenure goes up to 40 years. The investor can choose a duration suiting her requirement. Once an investor has purchased these bonds, the rate of interest gets locked in for a very long period, though not for life. When the bonds mature, the investor will be exposed to reinvestment risk.

An annuity plan allows the investor to lock in the rate of interest for the rest of his life.

Government bonds carry zero credit risk. The same can’t be said of annuity plans. However, if this plan is purchased from the Life Insurance Corporation (LIC) of India, then there would be almost no credit risk.

Both products receive similar tax treatment. Interest income from government bonds and annuity income from an annuity plan both get taxed at the investor’s slab rate.

As for liquidity, government bonds can be sold in the secondary market whenever the investor wants to exit. However, finding a seller could pose a challenge, given the low liquidity on the exchanges. In annuity plans (only with return of purchase price, or RoPP, variant), the investor can surrender the plan by incurring a penalty.

As for returns, government bonds are likely to offer a better rate of return than with RoPP annuity plans, but lower than without RoPP variants.

Two kinds of annuity plans

Let us examine the two primary variants of annuity plans:

With RoPP: These plans offer an income as long as the buyer is alive. On the buyer’s death, the nominee gets back the original amount invested.

Without RoPP: These plans offer an income as long as the investor is alive. On the investor’s death, the nominee doesn’t get anything back.

In the with-RoPP variant, since the insurance company must return the principal, the annuity rate is linked to prevailing interest rates and hence keeps changing. Upon investment, the rate at the time of purchase gets locked in.

In the without RoPP variant, the rate of interest depends more on expected longevity (and hence is determined by mortality tables and actuarial skills). Since the investment amount doesn’t have to be returned, the rate of return is higher than in the with-RoPP option.

Bond or annuity plan?

If you retire at 60 and want to guarantee yourself an income stream for up to age 90, buy a 30-year government bond. You will get your money back after 30 years. The other option is to buy the with-RoPP option of an annuity plan. LIC Jeevan Akshay VII is one such product.

The long-term government bond is likely to offer a better rate of interest than an annuity plan with RoPP.

Annuity plans score over government bonds on two counts. Firstly, they can guarantee you an interest rate for life. Government bonds can guarantee income for a long time but not for life.

Secondly, let us not ignore annuity plans without RoPP. They can provide a higher rate of return than government bonds, especially when purchased at the age of 70. The only caveat here is that the nominee won’t get anything back after the purchaser’s demise.

Most people stay away from without-RoPP annuity plans. The key risk in these plans arises if the purchaser dies early: he would not have received much income, and his nominee will also not receive any money. While this risk is definitely there, the merits of these plans outweigh their risks.

Without RoPP annuity plans can create immense flexibility in financial planning. You can earn higher income at low risk. This frees up a larger portion of your retirement corpus which can be invested in other instruments. The answer really is to buy the right variant at the right age.

Mix the two

Retirees don’t need to buy either one of the two options: government bonds or an annuity plan. Instead, they can use both. At the age of 60, they can invest in 10-year government bonds. Once these mature, then at the age of 70, they can invest a portion of the maturity amount in a without RoPP annuity plan. The rate of return on these plans turns very attractive at this age.

Retirees can also stagger their annuity purchases.

What to know

Both government bonds and annuity plans can offer a guaranteed rate of return

While the former can offer a guaranteed return for a long but limited period, an annuity plan can do so for life

Long-duration government bonds are likely to offer a higher rate of return than with RoPP annuity plans, but lower than without RoPP annuity plans

Invest in 10-year government bonds at the age of 60, then invest a portion of the principal you receive at the age of 70 in a without RoPP annuity plan

Rates of return on the latter turned very attractive at a higher age

(Deepesh Raghaw is the founder of PersonalFinancePlan and a SEBI-registered investment advisor.)