How to ensure regular income in golden years

D Ramanathan
Shriram AMC

The risk of living too long makes many avoid the thought of retired life, especially in this era of nuclear family. One should be in a position to fend for himself after he retires to ensure that the golden year remains golden. When the question of enjoying old age arises, the first thing that comes to mind of most Indians is ‘pension’ – technically known as annuity. Let us see how you can get a pension even if your employer does not offer you one.

What is an annuity?

A fixed sum of money paid at fixed intervals say monthly, quarterly or annually typically for the rest of one’s life like a pension. In India, less than 11% of the estimated working population is eligible to participate in a formal pension system and about 90% of the population does not come under the purview of any such mechanism. Hence, annuities are gaining popularity among investors, especially to address their post retirement needs.

Annuities are issued by life insurance companies like LIC, SBI and other private companies like ICICI Prudential, HDFC & Shriram Life. One has to buy a deferred annuity plan in his working life to get some pension when he retires.

Deferred annuity has two phases – the accumulation phase in which your premium is invested for a period of 15 -20 years and the distribution phase in which the corpus you have accumulated along with the returns can be utilized to buy an immediate annuity, which ensures regular income in golden years.

Deferred annuity plans can either be endowment or unit linked plans that offer returns offered by market. But is this the only way to plan your retirement corpus? Not really!

The cost structure of life insurance products are relatively higher due to agent commission, fund management fees, policy administration etc impacting the returns. Net of expenses, a traditional plan would give you returns around 6% per annum. Hence, it is advisable to diversify a part of your retirement investment to a low cost wealth creation product- mutual fund.

Mutual funds offer to invest in stocks, bonds and gold. For long term goals such as retirement, one should have exposure to stocks. One can start with equity mutual funds. For those, who don’t want to take 100% equity exposure, a balanced fund can be a good choice as it invests at least 65% in equities and the remaining in debt securities. While the stocks bring in returns, the bond exposure offers stability. Historically, balanced funds with more than 10 years track record have generated a compounded annualized growth return of 15 – 20%, significantly higher than most of the investment products. Balanced funds are treated as equity funds for the purpose of taxation. This means that the long term capital gain tax on balanced fund is NIL. Dividends too are tax free in the hands of the investor. Let’s look at a simple illustration of a retiree with a life expectancy of 25 years after retirement wanting an annual income of Rs. 12 lakh. Assuming the inflation & interest rate to be 6% and 7% respectively, the person would require a corpus of INR 2,68,64,663. As a thumb rule, the accumulated funds for retirement should be approximately 20 times the required annual income just before retirement.

One can accumulate his savings in equity funds and balanced funds using a systematic investment plan. This way he can build a large corpus over his working life. The money so accumulated can be used to buy an immediate annuity plan. Investor can choose the frequency of payment such as monthly, quarterly, half yearly and annually. Behaves like a fixed deposit, offering guaranteed return over the life of the investor. Returns offered in the immediate annuity plan vary between 5 – 7% and directly proportionate to the age of the investor and the amount of investment.

Currently there is no tax deduction at source. However, annuity income is subject to tax in the hands of the investor based on their respective tax slabs. For instance, a senior citizen (between 60-80 years of age) income up to Rs. 3 lakh is tax-exempt while in case of super- senior citizens (above 80 years), there is no tax on income up to Rs. 5 lakh.

There are wide ranges of variants to choose based on one’s preferences such as single life annuity and Joint life annuity Plan. Under each variant there are multiple options. For instance, under life annuity, the investor has the option to choose to get fixed income throughout his life and post his demise, payments would cease to exist and no further amount would be payable. Alternatively, under Life annuity with ‘Return of Purchase Price’, ‘the Invested Amount’ is paid to the nominee upon the demise of the investor. Since no two investors are alike, one should carefully choose the plan that is the most appropriate to them. One big drawback of annuity plans is that they are rigid and liquidity is poor. Like any other insurance product, there is a free look back period ie you can return the policy in case you’re not agreeable to any of the policy terms and conditions within 15 days from the receipt of the policy. The insurance company shall refund the invested amount subject to deduction of the stamp duty and any annuity payout if any.

If one falls in the high income tax slabs and not keen on annuity products, then he can look at opting for a systematic withdrawal plan from mutual funds. Investor can instruct the fund house to redeem units worth a fixed sum of money each month. Thus he can ensure regular income in his golden years. Sale of units of mutual funds is subject to capital gains tax. For the long term capital gains, the tax rate is lower as compared to 20% and 30% applicable to higher income tax slabs.

Disclaimer: Views are personal. No content on this article should be construed to be investment advice. You should consult a qualified financial advisor prior to making any actual investment or trading decisions. All information is a point of view, and is for educational and informational use only. The author accepts no liability for any interpretation of articles or comments being used for actual investments.