Annuity plans: Compare payouts from various options, understand trade-offs

To tackle inflation, consider hybrid or increasing annuities, or combine fixed annuity with mutual funds; for legacy planning, opt for return-of-premium options

Tata AIA Life Insurance has recently launched Shubh Flexi Pension Plan, an annuity plan, in association with Policybazaar. One part of the payout offers guaranteed income for life, protecting customers against longevity and reinvestment risks. The other part is linked to the Nifty 50, allowing the payout to grow in line with India’s equity markets. Customers can choose the balance between these two income streams at the outset.

 

Tackling inflation risk

 

One issue with annuity plans is that most make a fixed payout for life. Inflation erodes the value of this payout over time.

 

In this plan, a portion of the income gets locked in at the prevailing annuity rate for life. “This protects customers from falling rates and reinvestment risk. The variable payout component helps customers beat inflation,” says Sameep Singh, head of investments, Policybazaar.

 

The variable component, however, does not come with any guarantee. “This can lead to lower payouts during downturns in the equity market,” says Abhishek Kumar, Sebi-registered investment adviser and founder, SahajMoney.com.

 

These plans suit individuals looking for two main benefits. “Customers expected to retire within the next 5 to 10 years can opt for this type of annuity plan because it provides income stability and inflation protection,” says Gibin John, senior investment strategist, Geojit Investments.

 

Do not underestimate post-retirement expenses or select a lower guaranteed income than needed to cover essential costs. “Plan conservatively and avoid relying on optimistic return assumptions for the market-linked component,” says Madhu Burugupalli, head – product management & strategy, Bajaj Life Insurance.

 

A do-it-yourself alternative

 

Younger individuals with a high risk appetite may build a retirement portfolio independently using a mix of equity, debt and gold funds. “As they approach retirement, they can shift the required amount into risk-free annuity products or other stable return options,” says John.

 

Singh points out that a generic (and not labelled) portfolio runs the risk of funds being diverted to meet other financial needs.

 

Multiple payout options available

 

Annuity plans offer a range of payout options: Single life, joint life, with and without return of purchase price (RoPP), increasing annuity, and immediate and deferred annuity.

 

Those who want payouts to begin after a few years should choose a deferred annuity plan, while those who want payouts to start immediately should opt for an immediate annuity plan. People with dependent spouses should consider a joint life plan so that the payouts continue for the spouse’s lifetime.

 

Buyers must decide whether their priority is to maximise monthly income for themselves or ensure that their heirs receive the original investment after their death. “Investors who seek to do legacy planning may prefer the RoPP option,” says Burugupalli. Payouts are lower under this option than under the “without RoPP” option.

 

Burugupalli adds that individuals concerned about inflation may consider increasing annuities. These plans offer a fixed, pre-declared rate of increase.

 

Investors must first prioritise their needs, then compare the payouts from various options to understand the trade-offs.

 

Lock in today’s annuity rates

 

The biggest advantage of deferred annuities is the certainty they bring to retirement planning. “They allow a person to lock in an annuity rate today for a payout that begins later,” says Kumar. They also offer payouts for life, which to some extent safeguards a person against the risk of outliving their savings.

 

But liquidity is a concern. “Funds are usually locked in during the accumulation period, limiting access in case of unforeseen needs,” says Burugupalli. They typically carry high surrender penalties.

 

“The returns from a deferred annuity plan may be lower than the returns from a diversified investment portfolio,” says Kumar.

 

Before investing in a plan, compare annuity rates, which can vary significantly across insurers. Finally, avoid committing your entire retirement corpus to annuities, as that could cause liquidity problems. 

 

The writer is a Mumbai-based independent journalist