Source/Contribution by : NJ Publications
The pandemic has come as a wake-up call for many of us. People are now giving a lot more priority to the quality of life, living and not just working their entire life. Early retirement may be a recent phenomenon, but it would have crossed the minds of almost everyone today. However, retirement in India is not as easy as it looks. In absence of social security, lack of adequate savings towards retirement and the uncertainty of the finances makes retirement planning very challenging.
What are the retirement solutions available?
The most popular solutions for retirement solutions today are the schemes offered by government namely the NPS, the PPF, the Employees Provident Fund (EPF) and the Atal Pension Yojana (APY). However, being government schemes, they have their own set of advantages and disadvantages. A lot of investors do find they helpful but many also find them inflexible and constrained with limits on the maximum amount. Apart from this, many investors also invest in mutual fund schemes – both as a tool to create wealth and to manage retirement kitty. People are now also increasingly attracted to lifetime income products which are less volatile and are not market-linked. Such products are offered by life insurers and are popularly known as Annuity or Pension Plans. Let us explore them.
What are Annuity Plans?
Your retirement kitty, irrespective of where you save it, runs the risk of being exhausted in old age. Annuity plans are plans offering you a guaranteed income either for life or for a stipulated duration. By design, they protect an individual against the risk that he may live longer and exhaust his resources. Under an annuity plan, the investor normally pays either a lump sum or regular instalments in the accumulation period and then get regular payments as long as you are alive or for a pre-specified fixed period.
If you think about it, both an Annuity Plan and a Pure Term life insurance plans are complementing each other. Pure term insurance covers the financial risk of 'unexpected death' leaving the family without any financial support. An Annuity plan, on the other hand, covers you by providing adequate financial resources if you continue to live long!
Types of Annuity Plans:
Depending on when you buy them, annuity plans can be divided into two categories: Deferred Annuity and Immediate Annuity. An immediate annuity is one for which you pay a lump sum amount, rather than instalments over time, and then the plan pays you a regular guaranteed payout. An immediate annuity plan is mostly purchased by individuals who are about to retire and would like to receive a monthly income right away. A deferred annuity plan, on the other hand, may allow you to either pay a lump sum or pay premiums /instalments and build a corpus over a specified period. Post this, your annuity will start giving you fixed periodic payments for a chosen period or for life.
Advantages of annuity plans:
First, annuity plans come with the assurance that you will continue to receive money for the rest of your life. The insurance company takes on the risk of paying you for a lifetime.
Second, annuity plans eliminate reinvestment risk. Reinvestment risk is where you have to invest in future but the interest rates/returns available at that point of time in future may be very low compared to today. As you can imagine, there is a trend of falling interest rates in India which is already causing a lot of trouble to the senior citizens today. However, annuity plans with guaranteed rate of payout eliminate this risk.
Third, while there are investment caps in many other retirement plans, especially the government-backed schemes, there is no such investment caps/limit on annuity plans.
Lastly, annuity plans offered by insurers offer a lot more in terms of features and payout flexibilities. There are plans allowing you to add your other family members too (joint life) where your family member /spouse will receive the money after you. Some plans also offer you to receive lump-sum amounts, typically return of premium, after certain periods as per choice. There are also options available to add death benefit, critical illness, permanent disability benefits, etc. You may also have the option to add top-ups to the plan, typically available in a deferred annuity plan during your premium paying term.
How much will you get?
The ROI or return on investment on annuity plans often depends upon whether it is an immediate annuity plan or a deferred one and the duration of delay before the start of the annuity. Typically, insurers presently are offering between 5.1% to up to 5.9% for immediate annuity plans and up to 11.50% plus for those with deferment period. The longer the deferment period, the higher would be the promised returns. Please note that these are indicative rates and are dynamic in nature with changes normally happening every quarter for the new buyers. The simply put, it is a question of how the cashflows are planned. One can smartly create a smart ladder of multiple annuity plans too where your annuity income would increase /grow after every few years! It would be interesting to work that out with your insurance advisor...
Choosing An Annuity Plan:
Annuity plans, should not be seen as a substitute for mutual funds as both are very different in nature and have their own reasons to buy. A smart investor could club both of together – contribute a 'part' of the portfolio as a lump-sum in annuity while the remaining portfolio will continue to grow and will be freely available. You can even continue with your SIPs. While annuity will give the guaranteed cashflows, your mutual fund investments /SIPs would work at building your wealth – both different objectives. Further, they cannot be also readily compared with traditional insurance plans which mix insurance benefits with investments, often compromising both. Annuity plans are designed as cash-flow oriented plans and hence are a different breed altogether.
Like any other financial product, the key parameters for selecting the right annuity plans are safety, returns, and liquidity. We strongly suggest that if you are planning for retirement to explore the annuity /pension products offered by the insurers. They do score over many traditional, government schemes on many points. Before buying an annuity plan, please do take a look at the track record of the annuity provider, their reputation, financial strength and not just product features. It would be best to consult your insurance advisor on the same. For us, the elimination of uncertainty and having a guarantee in your sunset years wins the argument for annuity plans.