Planning to buy an annuity plan? Here's how you can choose the right one

It makes sense to have more aggressive instruments in your portfolio for improving income

Annuity plans are currently in the news. The Pension Fund Regulatory and Development Authority (PFRDA) is trying to put in place an online process for the purchase of annuities, so that payout of pension doesn't get delayed for National Pension Scheme (NPS) investors upon retirement. Also, Life Insurance Corporation of India (LIC) has recently launched Jeevan Shanti, a single premium plan where the investor can opt for either the deferred or the immediate annuity option. Investors who wish to buy either of these two types of plans should evaluate their pros and cons properly.

Lock into rates now: A deferred annuity plan has an accumulation phase and later a payout phase. “They allow you to lock your money now for retirement, while you are earning, thereby ensuring that it doesn't get used for other purposes,” says RM Vishakha, managing director and chief executive officer, IndiaFirst Life Insurance. Also, a deferred annuity will promise you a certain return today. “If you believe that interest rates will be lower in the future, lock into current rates now,” says Vishakha.

Unit-linked deferred annuity plans are also available. “The returns from these plans depend on the performance of the funds, subject to a minimum guaranteed vesting benefit,” says Saisrinivas Dhulipala, appointed actuary, Bajaj Allianz Life Insurance.

Many experts, however, warn against investing in deferred annuities. “The rate of return from guaranteed plans tends to be low at around 4.5 per cent,” says Rahul Agarwal, founder CEO, Ideal Insurance Brokers. Remember that the larger part of the corpus is invested in debt instruments, where returns are in single digit. Adds Deepesh Raghaw, founder, PersonalFinance Plan.in, a Sebi-registered investment advisor (RIA): “In the accumulation stage, there are many options like equity mutual funds, National Pension Scheme (NPS), Employees' Provident Fund (EPF), Public Provident Fund (PPF), debt mutual funds and fixed deposits. Use these to invest on your own and purchase an immediate annuity at 60.” 

      

Create an income stream for life: People who are on the verge of retirement should buy an immediate annuity to create an income stream for life. “Income from an annuity acts as a replacement for your salary. Besides, if you have invested in the NPS, or the pension plan of an insurance company, you need to compulsorily buy an immediate annuity with a part of the corpus,” says Vishakha. NPS investors have to use 80 per cent of the corpus to buy an annuity if they withdraw money before 60, and 60 per cent if they withdraw after 60. In case of an insurer's pension plan, 66 per cent of the corpus has to go into buying an annuity.

Immediate annuities offer two key benefits. “The insurance company pays a fixed income for life and thus guards you against longevity risk, which is the risk of a person outliving his corpus. It also guards you against reinvestment risk, which could arise from interest rates declining in the future,” says Santosh Agarwal, associate director and cluster head-life insurance, Policybazaar.com. They are particularly attractive for very senior citizens. “Those in their seventies and eighties find it difficult to manage their finances. A regular annuity income is attractive for them,” says Raghaw.

However, once you buy an annuity, liquidity becomes an issue. Also, the value of the fixed amount that you get from an annuity will erode due to inflation. Therefore, only a part of your retirement corpus should be put into immediate annuities. “Annuity income is also taxable, so avoid generating in excess,” says Agarwal.

One strategy buyers can adopt is to stagger their purchases.  The rate of return in an annuity plan improves with age, so staggering can be beneficial. “By staggering, you can negate the impact of the interest-rate cycle and spread your risks. If rates are down today, they may be higher five years later,” says Raghaw. However, if rates are on the higher side today, you may be better off buying more today.

Select right annuity option: Besides rate of return (see table), enquire about the quality of service of different annuity providers. A person also needs to choose the right annuity option. “Those who are single may only want an annuity for their lifetime. Those with a spouse may want the annuity to run for their lifetime and that of their spouse. Some people may want to pass on a legacy to their children. They may opt for the return of purchase price option,” says Srinivasan Parthasarathy, chief actuary and appointed actuary, HDFC Life Insurance.