Income after retirement: Risks and rewards of deferred annuity plans

Allocate just enough to generate a basic retirement income; over-investing in this illiquid product can backfire

Several insurance companies, including the Life Insurance Corporation (LIC) of India, have launched deferred annuity plans in the past few weeks. Customers need to understand the role these plans can play in their retirement portfolio before investing in them.    

Fixed, lifelong income
 

These plans offer a reliable income stream during retirement. “This is the only product that can provide a guaranteed income during retirement for as long as the customer lives,” says Srinivas Balasubramanian, head of products, ICICI Prudential Life Insurance.
 

With average life expectancy increasing, most people are uncertain whether their savings can sustain them during their retirement. “Only an annuity can take care of longevity risk—the risk of outliving your savings,” says Vivek Jain, head-investments business, PolicyBazaar.
 

Customers can use them to benefit from the current peak interest rates. “Choosing this option helps individuals lock in rates today for an annuity that starts making payouts in the future,” says Vaibhav Kumar, head-products, Max Life Insurance.
 

Interest rates have been declining over decades. “Not buying a deferred annuity today could mean you could get a lower rate when you buy an immediate annuity at the time of retirement,” says Jain.




 

Kumar adds that since the customer does not receive annuity payouts for the first few months or years, the amount of annuity payable increases.
 

This plan also provides protection against market volatility. It is also a simple product that customers can easily relate to. “You pay a certain amount to the insurer, which then gives you a fixed sum after retirement for the rest of your life,” says Deepesh Raghaw, a Securities and Exchange Board of India (Sebi) registered investment advisor (RIA).
 

Kumar highlights that the obligation to pay regular premiums promotes disciplined saving.

Returns not inflation-proof
 

These plans pay a fixed amount and hence do not offer protection against inflation. “A pension amount that is adequate today may not suffice after 10 years, given a consumer inflation rate of 6-7 per cent,” says Raghaw.
 

Their returns are also usually not high. Customers could earn a higher return from equities. “If you need the money after, say, 10 or 15 years, you have the option to take more risk by investing in a basket of diversified equity mutual funds, where it would grow at a faster rate,” says Raghaw.
 

These products lack flexibility. For instance, if you purchase an annuity at 40 with payouts starting at 60, but decide to retire early at 50 due to a windfall, you will still have to wait until 60 for the payouts to commence.
 

Their illiquid nature can cause issues. Consider a scenario where you are 40, saving for your daughter’s college education in 10 years while also investing in an annuity for retirement. Unexpected expenses arise, leaving you short of funds for her education. However, the money invested in the annuity is locked in and cannot be withdrawn.


ALSO READ: Payment options, return, terms of various pension plans explained

 

Opt if you prioritise certainty
 

People who prioritise long-term financial stability should go for them. “They are ideal for those seeking a reliable source of income in retirement,” says Kumar.
 

Customers in their late 40s or early 50s may consider them. “Those who believe that current interest rates are attractive but may not remain so for much longer may go for these plans,” says Balasubramanian. The alternative is to invest in a diversified portfolio of mutual funds over the next decade and subsequently purchase an immediate annuity plan. “That approach may not resonate with people who desire financial certainty,” adds Raghaw.
 

With or without return of purchase price?
 

In the with-return of purchase price (RoPP) option, which is more popular,  the premiums are paid back to the nominee once the annuitant dies. “This option is beneficial if the annuitant dies early after retirement. The premiums are returned to the nominee, ensuring the money is not lost,” says Raghaw.
 

Jain informs that many Indians use it to leave wealth behind to the next generation. However, this option also results in a lower monthly pension.
 

The without-RoPP option offers a higher pension, providing greater financial security during retirement. “Go for this option and maximise your pension. Use other investments you may have for legacy purposes,” says Jain.
 

Consider both return and brand
 

Buy the annuity from a reputable brand. “This is the product where the customer has the longest relationship with the insurer. The trustworthiness, scale, size and reputation of the brand become important parameters,” says Balasubramanian.
 

Compare returns offered by various insurers. Calculating the internal rate of return (IRR) is difficult as the product does not have a finite life. A simple solution is to compare the pension amount different insurers are promising.
 

Go with an insurer whose services are digitally advanced. “You don’t want to visit the branch in your 60s or 70s for things like existence verification,” says Balasubramanian.
 

Kumar suggests choosing the deferment period carefully. “A longer deferment leads to a higher annuity rate,” he says. Married persons must buy a joint-life annuity so that the spouse continues to get the pension after them. Avoid putting your entire retirement corpus in annuity plans. “Use this product to generate the basic income you will need in retirement. The rest should be in liquid and growth assets,” says Raghaw.

Know more about deferred annuity plans with these tables here and here.