Pension policies: Should you invest in annuity plans?

You need regular income to manage your expenses during the golden years of your life. Still, annuity plans are not so popular in India with many wondering whether they are worth investing in. One of the biggest worries is whether pension rates will be able to beat inflation and would be sufficient to generate regular income in the long term.

Experts say it is expected that interest rates might go up in the short run but as India moves to be a developed economy, inflation will fall and also interest rates. Hence, locking at higher rates than what might prevail in the future can be an advantage. Here is a low-down to what annuity plans offer in India:

Pension Rate

The pension rates are generally low as insurers are generally conservative because of the long-term nature of annuities. Moreover, due to the limited availability of long-term debt instruments, there are high chances of asset-liability mismatch which insurers do not want to be exposed to.

Amit Palta, chief distribution officer, ICICI Prudential Life Insurance said, “The annuity rate depends on the variant selected i.e. Immediate or Deferred annuity option chosen and age at entry of investment. At an industry level, the average rate of return ranges from 5.5% to 11.0% p.a. as per the period of deferment and other factors.  At the time of purchase itself, the customer gets to know the exact annuity rate on the investment and that remains constant and guaranteed for life.”

ICICI Prudential Life offers Guaranteed Pension Plan, with the ‘Early Return of Purchase Price’ feature upon the policyholder reaching 76 years or on turning 80. The product offers an innovative retirement solution that provides increased income to policyholders to keep pace with the rising cost of living.

Srinivasan Parthasarathy, Chief Actuary – HDFC Life, said, “Annuity plans offer guaranteed returns throughout the life of the annuitant. They don’t change, unlike other instruments. These rates depend on the customer profile like age, gender, and the annuity plan option chosen by the customer.”

He added, “Currently for Pension Guaranteed Plan (PGP), our annual rates are as follows. HDFC Life, for a 60-year-old male with Rs 10 lakh corpus (excluding taxes) opting for Single Life with ROPP (Return of Purchase price) – offers 5.85%. For 60-year-old male & 55-year-old female with Rs 10 lakh corpus excluding taxes opting for Joint Life with ROPP, the return would be 5.79%. For the company, overall annuity segment has grown despite having a slowdown due to Covid, as it registered a YOY growth of close to 46% as compared to FY20.”

New age tax-free annuity plans

While annuities are taxable, experts say guaranteed plans have become popular that offer the option of term cover plus annuities. Lovaii Navlakhi, CEO of International Money Matters said, “In the current scenario, insurance companies have come up with a term cover cum annuity plan which allows for the cash flow to be tax-free. This is one very important reason to opt for annuity plans as it protects against depletion of funds from income tax. Many of the annuity plans are for 20, 25, 30 years or more, and that is certainly a huge advantage.”

Not only higher returns, but these guaranteed plans also offer a tax advantage. Navlakhi added, “The post-tax IRR for such term cum annuity plans is 5.1%-5.2% per annum. For someone in the 30% tax bracket, that equates to 7.4% per annum pre-tax. That’s a great rate to lock in to, for the next 20, 25, 30 years especially as you expect rates to fall.”

The way these products work is that during the premium paying or deferment period, there is a large term cover, which goes away when you start receiving your payouts. Moreover, these policies give the option of covering two lives. “You could add a child or even a grandchild and the assessment of medical underwriting is based on the younger life. That way, this becomes a method to transfer legacy too,” said Navlakhi.

There are many plans such as HDFC Life Sanchay Plus and Tata AIA Life Insurance Fortune Guarantee Plus, which are offering guaranteed returns over the long term.

Types of annuity

Parthasarathy explains how annuity plans can be categorised as per concept & variant.

Concept wise – There is Return of Purchase Price option (ROPP), wherein the money used to buy the plan is returned to the nominees on the death of the annuitants and in the non-ROPP option, no money is paid back to the nominees on the death of the annuitants.

Variant wise – There is a single-life option, which covers only one life and the annuitant continues to receive annuity throughout his/her life. In the joint-life option, two lives are covered and the secondary annuitant is entitled to receive the annuities in the event of death of the primary annuitant.

There are three types of annuity plans – All these are available in single and joint life options.

1. Immediate Life Annuity – Here the annuity starts once one buys the plan and the annuity is paid as per the frequency opted. This is non-ROPP.

2. Immediate Life Annuity with ROPP – Here the annuity starts once one buys the plan and the annuity are paid as per the frequency opted. This is ROPP, wherein on the death of the annuitants the money used to buy the plan is returned back to the nominees.

3. Deferred Life Annuity with ROPP– Here the annuity starts at a later stage as per the deferment period opted. The deferment period may be between 1 to 10 years as chosen at inception. This too is a ROPP option.

What to do?

Before investing remember you need to pay tax if the income exceeds the taxable bracket, as pension is the taxable income. One can, however, consider new age guaranteed plans for the tax advantage they offer.

The secret is to pick the right plan and diversify your portfolio. “Annuity is not the only way of getting regular cash flow – you could get rental income, interest income on a bond or fixed deposit, a systematic withdrawal plan from mutual funds, or even dividend income. From a risk protection standpoint, making sure that dependency on any one source is not very high is comforting,” said Navlakhi.

“About 10% to 20% of your retirement requirement can come from annuity plans. However, if one is extremely risk-averse and has a high corpus where he can afford to earn a lower return, then this allocation can be higher,” said Shweta Jain, CEO and founder, Investogrpahy.