Here are a few point to analyse whether “It’s good to invest in annuities for retirement income”:
“Money is something you got to make in case you don’t die”.- Max Asnas
Imagine you are nearing retirement and have a billion rupees in hand, You would want to invest your money so that you get regular payouts for your daily needs and wants. BUT the million dollar question would be, “How long I’m going to live? Who will give me enough money to sustain my lifestyle, every month, till I die?”.
Well, the most likely answer to your question would be, “Buy an Annuity Plan”!
Annuity Plans are retirement plans, which provide regular, equal and guaranteed payments, until the end of your life. In financial terms, it covers the risk of “outliving your retirement corpus”. In simpler terms, they provide guaranteed payments to you at regular intervals, irrespective of how long you are going to live.
Though the returns are poor, and the payouts given are taxable, annuity plans are still bought by many people, so as to get secure, fixed payments until death. It is mostly because of the fear of living longer than expected and spending the corpus too quickly on buying/upgrading a house or on vacations or as gifts to grandchildren.
Are Annuity Plans “must-haves” for retirement?
NO! Annuities are not recommended, to be a part of your retirement planning strategy. The low returns, and lock-in of the invested corpus in annuities, coupled with taxable payouts is certainly not the best option available to get a sufficient retirement income.
If you have planned your retirement well and built a sustainable corpus, you can invest in other alternatives like Tax-saving Bonds, Fixed Deposits (FD) or even, Senior Citizen Savings Schemes (SCSS), to get better returns and accessibility to the invested corpus. You can even consider investing in Debt mutual funds and set up a Systematic Withdrawal Plan (SWP) for drawing income.
Some retirement schemes like National Pension Scheme (NPS) and Pension Plans from Life insurers, make it compulsory for the subscribers to buy an annuity plan, from a part of the maturity value. Before investing in any retirement product, it is important to understand how, and how much, are you going to get, after retirement.
The average returns from an annuity plan, is generally between 5.5-9% before tax, depending on the annuity option you have chosen. Instead of buying an annuity plan, it is wise to invest your retirement corpus in a mix of income, debt and equity asset classes, which will not only provide growth to your corpus but also provide sufficient income.
Types of Annuity
Many insurers, now offer different types of annuities such as the return of the purchase price annuity, joint annuity, annuity certain, deferred annuity, etc.
Based on the timing of payouts, annuities are available as
In this, the payouts start immediately on purchase.
In this, the payouts start after a certain period, to which the purchase amount is invested.
Other types of annuities available are:
Annuity with Return of Purchase Price
In this, you will receive regular payments until your death, and on your death, your nominee will receive the purchase price back.
In this, you and your spouse will receive regular payments until the end of life of the last survivor, amongst you.
To keep up the competition, insurers offer many more annuity options for customers. However, the payouts reduce, depending on the option you have chosen.
Advantages of Annuity Plans
Let us understand some of the advantages of annuity plans:
Guaranteed Income until death
Annuities provide regular and equal payments until the end of your life, thus creating a stable income source.
Eliminates Reinvestment Risk
Annuities guarantee a fixed rate of interest throughout your life and hence, you are shielded from falling interest rates.
No Cap on Investment
You can buy an annuity plan, for any amount you wish to as there is no cap on the investment.
Disadvantages of Annuity Plans
Let us understand some of the disadvantages of annuity plans:
Since an annuity is a long-term contract between the insurer and you; it provides lower returns as compared to similar products.
Annuity Purchase price cannot be refunded or redeemed, i.e. once an annuity is bought, the purchase amount has been locked forever and you will not have any access to capital.
Annuity Income is Taxable
All payments received from annuity plans, are taxable under your income tax slab rate, as “Income from Other Sources”.
No inflation-adjusted payments
Annuity plans disburse equal payments throughout your life. Since the payouts are not inflation-adjusted, it may be insufficient to maintain a decent lifestyle towards the fag end of your life.
Uncovered Risk of a short life span
If you die within a few years of buying an annuity plan, the payments stop immediately and the purchase amount is unrecoverable. Though the insurers offer options like Return of Purchase Price to address this, the regular payments for such options, are the lowest among all the annuities available.
If you observe, the disadvantages outrun the advantages of buying an annuity. The inaccessibility of the invested corpus and the payouts failing to keep up with the inflation should be a major deterrent for you to avoid annuity plans altogether.
Alternative Options to derive income during Retirement
The alternative options available, to invest your retirement corpus are Tax-Free Bonds, Fixed Deposits, Senior Citizen Savings Scheme, Debt Mutual Funds, etc. Let us explore how these options work as compared to an annuity plan.
These bonds are low risk, fixed income instruments, with a fixed tenure, fixed interest rate. The interest earned on these bonds is exempted from tax. The interest payouts are usually given out annually.The bonds are listed on stock exchanges, to offer an exit route to the subscribers.
However, the value at the time of sale depends on the prevailing interest rate conditions. Also, the sale of bonds attracts tax, on the capital gains.
Fixed Deposits (FDs)
These are also debt instruments, which offer a higher rate of interest than Savings account. The interest rate is fixed for a particular tenure, and the interest payouts can be opted, at an annual, quarterly or monthly frequency. The invested capital is easily accessible, as it can be withdrawn anytime, with or without penalty.
However, the interest received on FD is taxable at the Income Tax slab rate of an individual, thus reducing the effective return. Also, you may not get high-interest rates every time you renew the FD.
Senior Citizen Savings Scheme (SCSS)
This is a low risk, a government-backed scheme with a maximum investment limit of Rs.15 lakhs and interest rate of 8.6%. The tenure is 5 years, which can be extended by another 3 years. The payouts are given on a quarterly basis. The invested amount can be withdrawn anytime, but with a small penalty.
The interest payouts are, however, taxable.
Debt Mutual Funds
Debt funds invest in a mix of several bonds with different maturity dates. Debt Funds give a better return than FDs, at around an average of 8-9%. An SWP can be set up, to draw money periodically from the invested corpus.
However, all withdrawals will attract capital gains tax. Also, the returns of Debt funds are not guaranteed and varies on the bond yields.
If you observe, alternative options mentioned above, have better advantages over annuity plans. Your retirement income can be derived from investing across one or more of these products, rather than an annuity.
Annuities are not ideal retirement products, as they have many disadvantages. It is always advisable to construct your retirement portfolio, to include a right mix of income, debt and equity asset classes. You should lay emphasis on, not just the regular retirement income, but also on the growth and accessibility of the retirement corpus.