Deferred annuity plans: Ensure retirement income with guaranteed return

Inflation will reduce value of payout, so invest part of retirement corpus in growth instruments

Grant Thornton’s recent report titled ‘India’s pension landscape: A study on retirement reality and readiness’ highlights low engagement with annuity plans. It says 76 per cent of respondents had not invested in these plans, despite the role they can play in providing stable post-retirement income.

 

How do they work?

 

In a deferred annuity plan, the customer pays premiums, either once or over several years. This money is invested and grows over time. “Once a person retires, the corpus turns into a source of income as the person receives payouts. A deferred annuity plan allows a person to get a steady income stream during retirement,” says Casparus J H Kromhout, managing director and chief executive officer (CEO), Shriram Life Insurance.

 

A deferred annuity scheme has an accumulation stage and a payout stage. It is different from an immediate annuity scheme. “In the latter, the policyholder pays the insurer a lump sum. The company starts paying the policyholder right away, usually within a month or a year,” says Kromhout.

 

A deferred annuity can be either guaranteed-return or market-linked.  ALSO READ: Tackling low savings rate: Automate with SIPs, retirement accounts

 

Lock in returns

 

As a country develops, its interest rates witness a secular decline. “In a reducing interest rate scenario, a deferred annuity plan locks in the annuity rate in advance, mitigating interest rate changes,” says Maneesh Mishra, chief product and marketing officer, Bandhan Life.

 

Guaranteed return plans provide predictability. “They can offer investors a fixed return of around 6-7 per cent per annum. The annuity rates are locked in at the time of investment and are not affected by market movements,” says Vivek Jain, chief business officer of life insurance, Policybazaar.

 

For market participation, individuals may opt for deferred annuity plans based on unit-linked insurance plan (Ulip). “They offer market-linked growth. At vesting — typically at age 60 — the investor can withdraw up to 60 per cent of the corpus tax-free. The remaining 40 per cent (or more) must be used to purchase an annuity. Alternatively, the entire corpus can be annuitised,” says Jain.

 

A deferred annuity allows the corpus to grow tax-free. “You only pay taxes when you take the money out. Such a plan helps build a savings habit. Fixed and indexed deferred annuities can protect your principal,” says Kromhout.  ALSO READ: HNIs aim for early retirement but low savings, planning hold them back

 

Payouts impacted by inflation

 

Guaranteed return plans make fixed payouts. “Do not forget the impact of inflation on retirement expenses. A fixed annuity payout might not keep up with it,” says Abhishek Kumar, a Sebi-registered investment adviser and founder of SahajMoney.com.

 

Some of these plans come with high fees.

 

These plans also lack liquidity. “They levy hefty surrender charges, which can significantly reduce the amount you get back,” says Kumar. For instance, in a policy surrendered within the first seven years, the policyholder may only get around 50 per cent back as surrender value. One would also have to pay tax on the entire surrender value, as it is considered taxable income during the year.

 

Consider risk appetite, return

 

Start by assessing your risk tolerance. “Based on it, decide whether you want a fixed, indexed or variable annuity scheme,” says Kromhout.

 

Consider the return the plan offers. It should match your retirement needs.

 

Choose between a fixed payout for a set period (five, 10 or 20 years) and a lifetime payout. A fixed payout option usually pays more, but the buyer risks outliving the payouts.

 

Married persons should consider including their spouse in the plan to ensure that payments continue for the latter’s lifetime. Check the policy document for charges like surrender charges, annual fees and other costs.  ALSO READ: Savings a/c returns drop post RBI rate cut: Where to park your idle ₹1 lakh

 

Should you buy?

 

Guaranteed deferred annuity plans are suitable for risk-averse investors. “People aged between 45 and 55, who want a steady income during retirement, should go for these plans,” says Kumar.

 

Mishra adds that one may use deferred annuity to cover at least 60 per cent of expenses in retirement. Kumar says these plans work well for those who have other savings and are unlikely to need early withdrawals.

 

Those who may need liquidity should avoid these plans. “People who do not have a health cover in their retirement years should also avoid them, as they could end up blocking a large portion of their corpus in annuities and might face liquidity problems during a health emergency,” says Kumar.

 

Finally, compare annuity plans from different insurers, focusing on their payouts and fees.

 

Combine MFs with deferred annuities

 

*  Mutual funds (MFs) offer liquidity and tax efficiency during the accumulation phase

 

*  Deferred annuity plans assure a fixed lifelong income

 

*  Combine MF SWPs (systematic withdrawal plan) with an immediate or deferred annuity to secure growth (market-linked returns) with predictable income

 

*  For equity MFs, long-term capital gains above Rs 1.25 lakh annually are taxed at 10 per cent, making SWPs tax-efficient

 

*  Annuity payouts are taxed at slab rate (but there is zero tax under the new tax regime till Rs 12 lakh)