Midlife financial planning: Buy deferred annuity plan for assured income

Some portion of retirement savings must also be invested in growth assets and some in liquid ones to meet emergencies

In a recent master circular on life insurance, the Insurance Regulatory and Development Authority of India (Irdai) allowed partial withdrawals from deferred pension plans for specific reasons, such as higher education or marriage of a child, purchase or construction of a house, and treatment of major illnesses, etc. These withdrawals, permitted only three times during a plan’s tenure, cannot exceed 25 per cent of the total premiums paid till the withdrawal date.

Experts say the flexibility to access accumulated savings will make it easier for customers to buy a deferred annuity plan. 

“Allowing customers to dip into their accumulated savings gives them the comfort that in the case of specific life events, their pension plan can be used as a safety net,” says Srinivas Balasubramanian, chief of product, ICICI Prudential Life Insurance Company.

This facility should be used only in emergencies. “Withdrawing partially from the pension plans may chip away at the long-term sustainability of the pension plan,” says Sabyasachi Sarkar, appointed actuary, Go Digit Life Insurance.

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How do these plans work?

Two types of annuity plans exist: immediate  annuity and deferred annuity. In an immediate annuity, the payout from the plan begins right away. In a deferred annuity, it starts after a gap called the deferment period.

Deferred annuity plans have several variants. One is the single-pay variant where the customer pays a lump sum and gets a pension for a lifetime after the deferment period.   

The other is a regular pay or a limited pay deferred annuity. A person who is 45 years old may pay the premium for 10 years, remain invested for another five years, and start getting a pension for lifetime from age 60.

In the single-life variant, a person receives a pension for her lifetime. In the joint-life option, the pension is paid for the lifetime of both the annuitant and the spouse.

Without and with return of premium options also exist. In the latter, after the annuitants pass away, the premium is returned to their nominee.

Lock in the return

Deferred annuity plans are simple products that people can relate to easily. “They allow people to replace the income during their work lives with a reliable cash flow during retirement,” says Deepesh Raghaw, a Sebi-registered investment advisor (RIA). 

They also offer protection against market volatility and interest-rate fluctuations. Buyers get to know upfront the guaranteed income they will get after retirement. “The rate of interest gets locked in at the time of purchase. Reinvestment risk gets eliminated, providing financial security and peace of mind during retirement,” says Balasubramanian.

This ability to lock in the rate of return for one’s lifetime is significant. “While the return from these plans may not seem high currently, it could appear so after 30-40 years if interest rates decline over the long term, as is likely,” says  Vivek Jain, head-investments business, Policybazaar.com.

Only with an annuity plan can returns be locked in for one’s lifetime. “While government bonds have very long tenures, they are finite. If you live beyond that period, you face reinvestment risk,” says Raghaw.

An investor can accumulate a retirement corpus using mutual funds and buy an immediate annuity at the time of retirement. 

“The individual takes the risk of adverse change in annuity rates near to their retirement. This risk is fully insured with non-linked deferred annuity plans, which guarantee the annuity rate after deferment,” says Sarkar.

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Inflation erodes purchasing power

As the payout from these plans remains constant, inflation gradually erodes the purchasing capacity of this amount as the years go by.

Liquidity will also remain an issue. “If you need the money that you have put into these plans back during the deferment period, you will find it difficult to access it. You may lose a considerable portion of the premiums paid if you surrender,” says Raghaw. 

While the partial withdrawal facility and loan against these plans will take care of this issue partially, they will not solve it entirely.   

During the deferment period, the customer’s money gets invested in fixed-income instruments. In mutual funds and the National Pension System (NPS), the money can be invested in equities during the accumulation stage for higher returns.    

If you calculate the internal rate of return (IRR) assuming a hypothetical date when the annuitant dies, it may not appear high. However, it must be remembered that a guaranteed return, and that too for a lifetime, can’t go hand in hand with a high rate.

Points to heed

Ascertain your cash flow requirements. “There is no easy way out of these plans once you have entered them, so go for them only if you are not likely to need the money invested in them,” says Raghaw. Jain suggests putting a limited portion of retirement savings in these plans.

Some portion of the retirement corpus should be invested in growth assets and some in liquid assets. 

Ensure that you will be able to pay the premiums for the required period and the age at which payouts begin matches the start of your retirement. 

Those who wish to pass on some wealth to their heirs may go for the return of premium option, though doing so will reduce the payouts they get. “Those with a financially dependent spouse should go for the joint life annuity option,” says Jain.

When selecting a plan, Jain suggests comparing the payouts offered by various insurers. Other things being equal, go with the one offering a higher payout.  Give some weight to brand strength also.