Relax with annuities
20 March 2016
Floating rates are now the rule, even for small savings schemes. For retirees who can’t stomach uncertainty, immediate annuity is a great fit
Quick! Can you think of one investment product that promises you rock-steady income for the next 30 years? In the uncertain financial markets of today, where even small savings rates are ‘floating’ with the markets and you can get egg on your face trying to predict bank deposit rates, there is one product category that offers such certainty — Immediate Annuity Plans.
The Finance Ministry recently batted for these plans by asking retirees to buy them with their provident fund savings. But immediate annuity plans remain a much-maligned investment category. Financial advisors avoid them due to modest returns and insurers don’t promote them because they aren’t lucrative for them.
But immediate annuity plans do present a very good solution to two categories of investors. One is retirees who seek a minimum level of monthly income, without having to monitor or micro-manage their portfolios. Two are investors who need income security, but lack the financial savvy to understand or keep up with the shifting fixed income landscape.
BusinessLine combed through the immediate annuity offerings from all leading insurers in the market, for the following tips on how to choose the best plan.
Options on the menu
Immediate annuity plans at their core offer a simple proposition — you pay a lumpsum amount to the insurer (called purchase price) upfront. The insurer, in turn, promises you a regular income stream (called annuity) at yearly, half yearly, quarterly or monthly intervals, for the rest of your life. While most insurers offer them for investors in the 30-80 age group, a few even allow 100-year-olds to sign up. Once you lock in, these plans do not allow any revisions, surrender or exit.
But if this sounds easy, you may be foxed the moment you proceed to buy a plan. Life insurers offer anywhere from five to fourteen variants of the basic annuity plan on their menu. So, here are the key ones, de-jargonised.
# 1 Life annuity (also called life annuity without return of purchase price) is the vanilla option that finds a place in every insurer’s portfolio. It pays you a flat income for the rest of your life. On your death, the income will cease and your dependants will not be refunded your capital.
# 2 Life annuity with escalation pays you an income that rises at a certain rate every year. For instance, LIC’s Jeevan Akshay VI offers a 3 per cent increase, SBI Life’s Annuity Plus offers both 3 and 5 per cent options and HDFC Life New Immediate Annuity offers a 5 per cent escalation. But as these are calculated on a simple interest basis, if you start with a monthly income of ₹10,000, that will rise by just ₹300 or ₹500 a year for the rest of your life!
# 3 Life annuity with return of purchase price pays you a flat income for the rest of your life, with your capital refunded to your nominees after your death. The presumption here is that you would like to bequeath your wealth. This option is available with all insurers.
# 4 Life annuity with return of purchase price in parts pays a flat income and also returns the capital to you or your nominee, in parts. SBI Life’s Annuity Plus, for instance, repays 30 per cent of the capital at the end of seven years if you survive and 100 per cent of the capital at the end of seven years, to your nominee, if you don’t.
# 5 Life annuity with a guarantee period pays a flat income for a fixed number of years, irrespective of whether you live. One of the biggest worries that seniors may have about betting their shirt on an annuity plan, may be that they may not live long enough to enjoy its benefits. This plan sweetens the deal by guaranteeing a monthly income for a fixed number of years, to either you or your nominee. LIC’s Jeevan Akshay, HDFC’s Immediate Annuity, SBI Annuity Plus, Edelweiss Tokio Immediate Annuity all offer variants with guaranteed income for the first 5, 10, 15 or 20 years.
# 6 Joint life annuity pays you or your nominee a certain income as long as either of you is alive. If you would like income security for your dependants who aren’t financially savvy (spouse/children) this is the plan for you. You can choose between 100 per cent of your pension for your dependants, or 50 percent.
How to choose
While all these bells and whistles may make your head spin, you should make your choice of plans based on just two criteria. The first is returns. Annuities are already low-return products. If getting the most bang for your buck is your primary objective, the life annuity (without return of purchase price) is your best bet because, across insurers, it fetches you the highest monthly income. A ₹10 lakh investment in LIC’s Jeevan Akshay’s vanilla plan fetches ₹93,500/year. But choose the guaranteed income or 3 percent escalation, and the income drops to ₹87,900 or ₹75,300!
While opting for return of capital may be tempting, there’s no point to it because your capital — 20 or 30 years hence — will be quite moth-eaten by inflation. Instead of seeking a return of capital from your annuity plan, you can create a separate corpus through an inflation-beating instrument like a mutual fund to pass on wealth to your dependants.
The income escalation clause is pretty meaningless too, as it is calculated on simple basis, it does only a half-baked job of compensating for inflation.
The second criterion is whether you would like to set up an income for your dependants too. If you do, joint annuity plans with 100 per cent annuity (without return of purchase price) will be your best bet. While slashing that pension to 50 per cent (on the theory that household expenses will halve on your death) may seem attractive on paper, remember that your annuity income doesn’t grow with inflation.
In fact, the inability of annuity income to keep up with inflation is a big minus for all investors and they should look to other investments that can fulfil this purpose.
Shopping for returns
The returns from annuity plans vary with the long-term interest rates in the economy. Today, the returns are at higher levels (compared to the past) because market interest rates haven’t fallen sharply from the peak in the current rate cycle.
Usually, you can gauge the returns from an annuity plan from the illustration provided by each insurer. It tells you how much annual income you can ‘buy’ with a purchase price of ₹1 lakh, at differing ages of entry. Or he may mention an ‘annuity rate’ that gives you the same information in percentage terms. Going by the rates compiled by BusinessLine from leading insurers, there’s a significant divergence in the annuity rates offered by different insurers in the market.
In effect, for a ₹50 lakh purchase price, the monthly income on offer ranges anywhere from ₹33,216 to ₹39,683. The best rates in the market seem to be offered by Edelweiss Tokio Immediate Annuity (₹9,524 per lakh), HDFC Life Immediate Annuity (₹9,380) and LIC Jeevan Akshay VI (₹9,350). Most insurers also peg up their offers for higher investments of ₹5 lakh or more. Shopping around for good deals can therefore significantly bump up your monthly income.
One caveat, though. While the ‘annuity rate’ may be an easy way to compare between the plans of insurers, don’t make the mistake of using it to pit annuity plans against other assets like bank deposits. A bank deposit offering 9 per cent interest is far superior to a life annuity plan offering a 9 per cent ‘annuity rate’, because in the former, you will also get back your capital.
To make a correct comparison of annuity plans with other debt products, you need to calculate the internal rate of return (IRR) on the actual cash flows. But the beauty of the annuity product is that the longer you live, the better your returns from it. Consider a 60-year old investor who buys LIC’s Jeevan Akshay VI today, at ₹9,350 for a purchase price of ₹1 lakh. If he lives to 80, his IRR would be just 7 per cent. But if he turns out to be a nonagenarian, lo, his return jumps to 9 per cent!
Ask any financial advisor why he never recommends annuity plans and he would usually cite taxation. One, the purchase price that you pay to buy an immediate annuity plan doesn’t enjoy any real tax breaks. Though exempt under Section 80CCC, the investment gets clubbed with scores of other products, and is subject to an overall cap of ₹1.5 lakh a year.
Two, the purchase price of an annuity plan is subject to service tax. With Budget 2016 slashing this tax, you now have to pay ₹1,400 additionally (it was ₹3,500 earlier) for every ₹1 lakh you invest in immediate annuity plans. This may not look like much, but its impact can really pinch on large investments. Three, the regular income you receive from your annuity plan is taxable at your income tax slab rate. Here the only solace is that you may fall in the lower tax brackets post-retirement.
Currently, the pre-tax return (IRR) for an investor who parks ₹1 lakh in LIC’s Jeevan Akshay’s life annuity plan (we assume the investor is 60 and lives on to 85), is about 8 per cent. If we factor in the service tax and a 20 per cent income tax, the post-tax yield drops to 5 per cent!
But with most fixed income options from bank deposits to post office being swept into the tax net, of late, this tax disadvantage may well fade in the future.
Tips and tricks
So, if you’re all set to buy an immediate annuity plan based on the above analysis, here are five tips to get the most bang for your buck:
Time your investment to a high point in the interest rate cycle. The rates you lock into at the start will decide your income for the next 30 or 40 years
Choose the plain-vanilla life annuity without return of capital to maximise returns
Annuities are the rare investment where a later start fetches you better rates. An 80-year-old signing up for a Jeevan Akshay policy will get 90 per cent more income than a 60-year-old
Given the extremely long-term nature of the investment, look for insurers with a 10-year track record in the Indian market. You want the insurer to outlast you!
As you get better annuity rates for bigger ticket sizes, club your purchases and buy them from a single insurer