Guaranteed return, tax breaks key benefits of retirement-focused insurance

Remember that their internal rate of return could be low, and unlike annuities, they do not make payments for life

“Invest Rs 1 lakh yearly, get Rs 2 lakh annually.” Doesn’t this also sound like a great investment? You pay Rs 1 lakh every year for 15 years, and then receive Rs 2 lakh annually for the next 15 years, effectively doubling your investment.

 

If you are a salaried employee in your early- to mid-forties, this may strike a chord. One of your biggest worries is managing expenses after retirement, when income stops but expenses continue. Retirement-focused products that promise certainty can therefore look attractive.

 

Appeal of guaranteed returns

 

These products are simple, transparent and easy to understand. The returns are guaranteed, and locking into a fixed rate feels reassuring at a time when the future of deposit rates is uncertain. They also come with a small life cover.

 

The biggest appeal lies in their clarity: you know in advance how much you will pay, how long you will pay, the deferment period, what you will receive once payouts begin, and for how long.

 

Even if brochures add features such as “guaranteed additions”, the essential structure remains straightforward enough to calculate what you will get and when. You can also calculate your final returns in case you survive the policy term.

 

Where the problems lie

 

The marketing pitch of “Pay Rs 1 lakh, get Rs 2 lakh” can be misleading. Unless you compute the internal rate of return, you may assume the offer is better than it is. In reality, a longer premium payment term or a longer deferment period sharply reduces the net returns, while extending the payout period does not change the IRR much. Do the IRR calculation exercise to know what you are getting into, then decide whether the return is sufficient for a long-term product. Doing this exercise will reduce the scope for disappointment later.  

 

Another concern is that these are long-term contracts that are expensive to exit. You risk getting stuck with a plan that may no longer suit your needs.

 

The deferment trap

 

The deferment period — the gap between the last premium payment and the first payout — is often presented in a way that creates confusion. A brochure may say you pay for 10 years and start receiving income from the 12th year. Since premiums are paid at the start of the year and payouts at the end, the first payment is effectively received only in the 13th year. This gap of three years, instead of the two suggested in brochures, works to the insurer’s advantage.

 

An important point to note is that an increase in the deferment period reduces the insured’s net returns from the product.

 

Should you invest?

 

I do not own such products, nor do I plan to add them soon. But financial planning is rarely perfect. Sometimes a slightly sub-optimal product still makes sense if it provides peace of mind. These policies may be considered for covering basic retirement expenses, though they should not form the entire retirement plan.

 

Inflation must be factored in, and other investments need to be explored for growth and flexibility.

 

How they differ from annuities

 

Both these and annuity products are non-participating life insurance plans, but the crucial difference lies in risk. With annuities, the insurer guarantees lifetime income and bears the longevity risk. With these policies, the insurer pays only for a fixed number of years, leaving the risk of outliving your savings with you.

 

This makes them inferior to annuities in terms of protection, but they do have a tax advantage. Annuity income is fully taxable at your marginal rate, whereas payouts from traditional insurance plans are exempt, provided the total annual premium across such policies does not exceed Rs. 5 lakh and the life cover is at least 10 times the annual premium. These conditions explain why traditional plans enjoy tax benefits while most annuities do not.

 

(The writer is a Sebi-registered investment advisor)