India becomes test case for impact bonds
It makes sense to have more aggressive instruments in your porfolio for improving returns
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.
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, thereby ensuring that it doesn’t get used for other purposes,” says RM Vishakha, managing director and chief executive officer, India-First 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 return 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, PersonalFinancePlan.in, a Sebi-registered investment advisor (RIA): “In the accumulation stage, there are many options like equity mutual funds, NPS, Employees’ Provident Fund (EPF), Public Provident Fund (PPF), debt mutual funds and so on. Use these 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 replace their salary. “If you have invested in the NPS, or the pension plan of an insurer, 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.
However, once you buy an annuity, liquidity becomes an issue. The value of the fixed amount that you get from an annuity will also erode over time due to inflation. Therefore, only a part of your retirement corpus should be put into immediate annuities. “Annuity income is also taxable,” says Agarwal.
One strategy that those buying annuities can adopt is to stagger their purchases as the rate of return in an annuity improves with age. “By staggering, you can negate the impact of the interest-rate cycle. 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 buy more now.
Select right annuity option:
Besides rate of return ( see table), also 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 who have 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. The amount you get each month will be lower in the joint life option than in the single life option. If you opt for the return of purchase price option, the amount you get will be lower than if you don’t opt for it. Which option you go for should also be determined by the size of the corpus you have accumulated.
Besides annuities, a part of your retirement corpus should also be invested in products like Senior Citizens Savings Scheme (return 8.7 per cent, tenure five years), Pradhan Mantri Vaya Vandana Yojana (return 8 per cent, tenure 10 years), and fixed deposits (SBI 1-10 year rates are 6.657.35 per cent).