Multiple benefits of deferred annuities: How you can choose the right one

Savvy investors can expect to earn better returns by investing in alternatives

With interest rates on fixed deposits (FDs) declining — State Bank of India pays 5-5.4 per cent to non-senior citizens for a 1-10-year tenure — investors are on the lookout for alternatives. One product that is being hawked aggressively is the guaranteed-return deferred annuity plan.

Here, the customer pays premiums for a certain period. For instance, a customer may enter at 50 and pay premiums for 10 years. Payouts don’t begin immediately (hence, the name ‘deferred’ annuity), but at retirement. Thereafter, depending on the option chosen, the customer could receive a fixed payout for his lifetime.

Protection against interest-rate risk

Nowadays, when employees retire, they get the money accumulated in their Employees’ Provident Fund (EPF) or National Pension System (NPS) account. Employers don’t give a life-long pension anymore.

“One could have a retired life extending for 25-30 years. An annuity plan is an effective tool to ensure individuals receive income in a sustained manner throughout this period,” says Tarun Chugh, managing director and chief executive officer, Bajaj Allianz Life, which recently launched a deferred annuity plan — Bajaj Allianz Life Guaranteed Pension Goal.

Rates of return on fixed-income products get revised in tandem with interest-rate movements. This makes investors susceptible to reinvestment risk, which deferred annuity plans can safeguard against.  

Inflation risk still exists

Deferred annuity plans tend to offer a relatively low rate of return.

“If you calculate the extended internal rate of return, it will mostly be in the 4-5.5-per cent range,” says Deepesh Raghaw, founder, PersonalFinancePlan, a Securities and Exchange Board of India-registered investment advisor.

The pension paid remains fixed

“If payout begins 10-20 years after entering the plan, by then inflation will have eroded the value of the pension amount considerably,” says Mrin Agarwal, founder-director, Finsafe India.

Watch out for mis-selling of this product. Suppose a customer has to pay Rs 1 lakh as premium for 10 years, or Rs 10 lakh altogether after which payout will begin. The plan will pay Rs 10,000 per month, or Rs 1.2 lakh per year thereafter. The agent could tell the customer that the product guarantees a 12 per cent return for life.

“What the agent failed to take into account was the time value of money — the period for which premium was collected, but no payout was made,” says Arnav Pandya, founder, Moneyeduschool.

Who should buy?

Ultra-conservative investors, or those who are not financially savvy, may opt for these plans. It is also suitable for those who lack the discipline to save regularly and stay invested in equity mutual funds (MFs) during turbulent phases in the market.

The DIY route

If you are a savvy investor, or have an advisor, you can expect to achieve better returns by using other products. One alternative is the NPS, where you can select an equity-debt mix according to your risk appetite and also track your progress.     

You can also segregate the accumulation and the payout phase. During the former, use a mix of equity and debt. On the equity side, use index funds or active MFs. On the debt side, use EPF, Public Provident Fund, and debt MFs.

In the payout phase, use a part of the accumulated corpus to buy an immediate annuity. Let a part remain invested in equities to provide protection against inflation. Invest the rest in a mix of Senior Citizens Savings Scheme (7.4 per cent), Pradhan Mantri Vaya Vandana Yojana (7.4 per cent), and systematic withdrawal plans of debt funds.