Annuity plans from insurance companies are tax-inefficient and their returns are unlikely to beat inflation
They won’t help you beat rate changes, so understand them before investing
Planning for retirement can be a cause for worry, especially given the falling interest rate scenario. Senior citizens’ biggest concern is finding a regular source of income that can replace their salaries. One of the options that you will find in the market are annuity plans offered by insurance companies.
Many life insurance companies offer these plans in India. In the past few months, Life Insurance Corp. of India (LIC) has launched updated versions of its two annuity plans—Jeevan Akshay-VII and New Jeevan Shanti—with lower interest payouts compared with its earlier plans.
Insurance agents pitch annuity plans as those that offer guaranteed regular income for life. However, before falling for the guaranteed-returns-for-life pitch by the insurance agent, understand what annuity plans are, why the sales pitch is flawed and other options you can explore for regular income after retirement.
What are annuities?
Annuities are pension plans sold by insurance companies that pay a fixed sum at regular intervals—monthly, quarterly, half-yearly or annual.
The key advantages of annuity plans are that they provide an assured payout for the rest of your life, eliminate reinvestment risk as the payout is fixed for life, and there is no investment cap.
However, at the same time, these products offer low returns, are tax-inefficient and lock up your money forever.
The sales pitch of insurers is a simple one. Annuities can help you lock in the rates so that you don’t have to worry about their movement. Sample this: In 2008, State Bank of India (SBI) offered a rate of 10.5% on its 1,000-day fixed deposit. The rates are now 5.1% for deposits between two and three years. The agent could give the logic that interest rates in India have been falling over the years, so investors should lock into current rates as even 5% returns, which annuities are giving right now, may look attractive some years from now.
Experts, however, don’t agree with this. “If the interest rates are expected to fall continuously in the future and remain low for a very long time, then it may make sense to lock annuity investment at these rates. But in India, historically, interest rates do not remain low for long. The rates are low right now and could gradually increase once the environment starts improving," said Harshad Chetanwala, co-founder, MyWealthGrowth, a mutual fund distribution firm. If the interest rates start to rise in the future, the investor would regret locking in the money at a lower rate.
Many buyers also misunderstand that annuities are tax-free like all other insurance options. “Pension is fully taxable as per the tax slab, which make post-tax returns from annuity extremely low," said Mrin Agarwal, founder, Finsafe India Pvt. Ltd, and co-founder of Womantra.
Sebi-registered investment advisers don’t prefer annuities for low returns, lock-in and taxability.
They suggest popular avenues such as Senior Citizen Savings Scheme (SCSS) and Pradhan Mantri Vaya Vandana Yojana (PMVVY) instead. They offer a better rate of return and liquidity. Both of these schemes offer a 7.4% interest rate.
Advisers also suggest retirees to use systematic withdrawal plans (SWP) of debt mutual funds. They can put the retirement corpus in a short-duration fund and set up a SWP to meet the monthly expenses of the seniors. “An investor can start the SWP after three years of investing for better tax-efficiency," said Agarwal.
If you withdraw from a debt fund before three years, you pay tax at your marginal rate; after three years, the gains are taxed at 20% along with the benefit of indexation. So if you stay invested for more than three years, the returns are more tax-efficient for those in the 30% and above tax brackets. Debt funds also offer liquidity, unlike annuity plans that lock in your money for life.
However, remember that debt mutual funds can be risky. “Short-term debt funds provide better risk-adjusted returns compared with medium- and long-duration funds," said Agarwal.
Besides debt funds and traditional fixed instrument investments, retirees can also look at buying tax-free bonds from the secondary market. However, remember that debt markets in India are generally illiquid. Also, dealing with the debt market would entail calculating yields and detailed evaluation for which retirees may need to seek help from experts.
Mint Money take
Despite the drawbacks of annuities, they can be included in retirees’ portfolios in small doses but only if they have a surplus after accounting for their living expenses and other needs, according to financial planners. Annuities may also work for those retirees who don’t have the discipline to maintain their retirement corpus and are likely to indulge their loved ones instead of securing their own future.
However, annuities can’t make your entire retirement corpus. They are tax-inefficient, lock in your money forever and their returns are unlikely to beat inflation. Moreover, making assumptions about interest rate movements can be highly risky.
Based on the overall retirement corpus need and time, retirees can strategize investments and go for a combination of debt fund SWPs, instruments like SCSS and PMVVY, and annuities, if required.
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