Nikhil Walavalkar & Preeti Kulkarni
For retirees, identifying an instrument that safeguards their nest egg and provides a regular income during their retirement years is a critical task. While several such avenues – the senior citizens saving scheme (SCSS), Pradhan Mantri Vaya Vandana Yojana (PMVVY) and post office monthly income scheme (POMIS) – are available, none of these guarantee income for life. And, this is precisely the gap that immediate annuities seek to fill.
Who can invest in annuities?
Anyone with a retirement corpus can sign up for immediate annuities. For National Pension System (NPS) subscribers, it is mandatory that they use 40 per cent of the corpus at maturity to buy annuities. However, the instrument comes with its share of limitations – annuity income is taxable and returns tend to be lacklustre. They range from 5.6-7 per cent per cent, depending on the annuity provider, the investor’s age at entry and the option chosen, among other factors.
The Life Insurance Corporation of India (LIC) is the most dominant player in the space, controlling over 90 per cent market share. Its investment assets in the pension, general annuity and group fund segment were valued at Rs 7.79 lakh crore as of September 2019.
NPS and regular income
The instrument was in the news once again recently, with the Pension Fund Regulatory and Development Authority (PFRDA) announcing that it is considering offering an alternative – systematic withdrawal plans – to annuities. At present, NPS subscribers can, once they turn 60, withdraw 60 per cent of their corpus without paying tax. However, the balance 40 per cent has to mandatorily be used to buy annuities.
All life insurers offer annuity schemes, but in case of NPS, the Pension Fund Regulatory and Development Authority (PFRDA) has empanelled seven annuity service providers. These include LIC, SBI Life, HDFC Life, ICICI Prudential Life, Kotak Life, Star Union Dai-ichi Life and IndiaFirst Life.
Deferred vs immediate option
When you pay a lumpsum to buy an immediate annuity, the insurer promises to pay you a regular income.
In the case of a deferred pension product, when the accumulation phase – investments are made regularly – is over, the corpus is used to buy an annuity. The quantum income depends on the age of the annuitant (the person buying annuity product), frequency of payment of regular income (annuity) and the option chosen.
Know your options
The frequency of payment is a function of one’s need and the option chosen becomes the deciding factor. Here are the options that are typically on offer.
Annuity for life: Here the life insurer pays the annuity till the policyholder is alive. After the death of the policyholder, the annuity stops and the purchase price paid to the insurer is retained by the insurance company.
Among all options available, this choice fetches the highest amount of regular income. This option works for those who do not have any dependents financially, or do not have any family members or who do not want to anyone else to enjoy the wealth after their death.
Annuity with guaranteed period and life thereafter: A person may ask for guaranteed payouts for a stipulated period – say, 5, 10, 15 or 20 years. Even if the annuitant survives beyond the period for which the payouts were guaranteed, she continues to get paid by the insurer till her death. The purchase price stays with the insurer after the death of the annuitant or the guaranteed payout period, whichever is later.
In case of the death of the annuitant during the period of the guaranteed payout, the insurer directs the benefits to the nominee appointed by the annuitant or to his/her legal heirs. For a longer period of guaranteed income, the quantum of annuity decreases. For example, the amount of annuity payable for a guaranteed period of five years and life thereafter will be more than that for the guaranteed period of ten years and life thereafter.
Immediate annuity for life with return of purchase price: This option works for those wishing to retain the purchase price. The annuitant enjoys the payout, and after her death, the purchase price is paid to her nominee.
Immediate annuity for life increasing at a simple rate: Inflation is the biggest enemy of most investors. In the long run, it can eat into one’s fortune. The income may appear good today, but over a period of time, it may not be sufficient. In all options mentioned above, the annuity, once fixed, does not change. To overcome such a scenario, this option can be taken. So, the annuity amount increases each year at a stipulated rate of, say, three per cent. The amount of annuity for the first year is clearly mentioned and so is the rate of increase. The rate of increase is computed using a simple rate of interest.
Joint life annuity: This options work for those wanting to provide for their spouses. There are options to provide the same amount of annuity to the spouse or half the amount in case of the death of the primary annuitant.
One can also choose 100 per cent annuity with the last survivor option under the joint life annuity and ask for return of purchase price.
As a rule of thumb, the more the guaranteed amount, the lower the annuity. If the regular payout is started late in life, the amount is also high. For example, the annuity you get if you start the payouts at the age of 45 will be lower compared to the amount you would get if payouts begin at the age of 60. Mortality rises with the age. Annuity payable monthly, quarterly or half-yearly is reduced by a pre-defined factor as compared to annuity payable yearly. Consult your advisor to understand if these products fit your goals.