Have you drawn up a bucket list of things to do after you retire? Almost everyone has plans for the period when every day is a Saturday and ‘work from home’ turns to ‘stay at home’. Some may want to travel, others may want to take up a long neglected hobby, while some others may just want to sit back and relax. The wants may differ for individuals, but one retirement need is universal: not to run out of money in the sunset years. It is a fear that haunts many Indians. According to the India Retirement Index Study conducted by Max Life Insurance, three out of five Indians believe their savings will not last more than 10 years in retirement, while one out of three believes the savings will not last more than five years (see graphic).
That’s a disturbing statistic, given that the average Indian is expected to live up to a little over 70 years. That’s the all-India average life expectancy at birth. At the age of 60, the average upper middleclass Indian in an urban area, with good nutrition and access to medical care, has a life expectancy of more than 80 years. So if one runs out of his retirement savings in 10-12 years, he will be living in penury for the next 8-10 years. “If you haven’t planned for a nest egg big enough to last 20-25 years in retirement, be ready to face financial difficulties in later years,” warns Raj Khosla, Managing Director, MyMoneyMantra.
How to get income for life
For retirees, the most important financial goal is to earn a regular income from retirement corpus so that they can live comfortably in their sunset years. It is also the most challenging. The very thought of investing the retirement corpus in market-linked products is daunting. One downturn can wipe out a big chunk of the corpus and set them back by years. On the other hand, fixed income instruments offer low yields and short tenures. Interest rates also keep fluctuating, and there is no long-term assurance. There is, however, one product that assures a continuous stream of income for life. Annuities are designed to give regular income to the buyer for the rest of his life. The buyer puts a lump sum into an annuity and gets a pension in return. Annuities have various options. It can be an immediate annuity, which starts giving pension from the very first month, or it could be a deferred annuity, which starts paying after a certain period of time.
Annuities are aimed at people in different life situations. If you want a predictable income in retirement, don’t have dependants, or your spouse is not financially savvy, or you lack financial discipline, you should opt for an annuity (see graphic). “Annuities are a very powerful product. They provide peace of mind by giving a steady stream of income to the retiree,” says Rishi Piparaiya, financial mentor and author of Three Pigs to Financial Freedom.
Opt for annuities if you…
Want assured income
Annuities give low returns but also offer assurance of income for life, peace of mind.
Don’t have dependants
Opt for it if all dependants are settled and you don’t need to leave anything behind after death.
Know your spouse can’t manage
It’s a good option if your spouse is not financially savvy and won’t be able to manage money.
Lack financial discipline
Can’t handle money yourself? Annuity takes away liquidity so there is no scope for mistake.
Expect interest rates to decline
Go for it if you expect interest rates to fall in the future and want to lock in at the current level.
This assurance comes at a price. Annuity rates have risen in recent years, but are not comparable with the returns from other fixed income instruments. The government-managed Senior Citizens’ Savings Scheme,for instance, gives 8.2%, and the Post Office Monthly Income Scheme gives 7.4%, while banks are offering 7.5-8% on fixed deposits to senior citizens (see graphic). To be sure, these products are not comparable to an annuity. They do give assured income, but the maximum tenure is five years. After a deposit matures, the buyer will have to reinvest the money at the rate prevailing at the time. There are also limits on how much an individual can invest in these schemes. An annuity, on the other hand, offers income for life. You have a guaranteed cash flow no matter how long you live.
Whether you live till 80-85 or even score a century, the monthly cheque won’t stop coming. “An annuity transfers the risk of longevity from the buyer to the insurance company. It gives the assurance of regular income till the end of one’s life,” says Rohit Shah, CEO of Getting You Rich Financial Planners. The buyer can also opt for a joint life annuity with a spouse. After the buyer dies, the spouse will get the income for life. However, a joint life annuity will offer a lower pension because it covers two lives (see graphic). The pension amount here will depend on the age of the spouse.
The greater the age difference between the buyer and the spouse, the lower the pension. The returns offered by annuities also pale in comparison to the returns from market-linked instruments. Equity-linked instruments can yield high returns, but come with very high risk that retirees baulk at. Even conservative hybrid funds, which allocate only 15-20% to equities, have given upwards of 9% in the past 10 years. But these instruments cannot match the assurance of regular income that annuities offer. “Annuities are a trade-off between high returns with fluctuations and relatively low returns with certainty,” says Jayant Pai, Head of Marketing at PPFAS Mutual Fund.
Taxation is a pain point
One major drawback in annuities is the tax treatment. The income from an annuity is treated as regular income and fully taxed at the slab rate applicable to the investor. This is a bit unfair, especially for those who opt for an annuity without return of principal. In this case, the income from an annuity would be a mix of the principal and the interest it earns. Just as in a systematic withdrawal plan from a mutual fund, investors should be taxed only on the gains. Yet, in case of annuities, the buyer is taxed for the entire amount received. Champions of annuities don’t see this as a problem. They contend that the total income of the investor will be lower after retirement, so the tax will not pinch too much.
The insurance industry has been lobbying for better tax treatment of annuity income for years, but to no avail. Though primarily meant to give a monthly pension in retirement, annuities can be used for any purpose that requires a recurring payment. In Piparaiya’s housing society, a resident used to feel pressured every time the quarterly maintenance charges were due. “He wanted to pay a lump sum to the housing society and be done with it forever,” he says. But the housing society had never handled such an unusual request and declined. That’s when Piparaiya suggested he should put the money in an annuity and pay the quarterly charges with the pension that flowed in. “An investment of Rs.25 lakh in a simple annuity with return of principal option would give him roughly Rs.50,000 every three months,” he says. After him, his wife would get that income, and after her death, the nominees would get back the Rs.25 lakh that was invested.
How much to put in annuities
Experts say a retirement portfolio should ideally be a mix of several instruments. “The real benefit of annuities is the lifelong income. So we recommend that at least 40-50% of the retirement portfolio should be allocated to these,” says Vivek Jain, Head of Investments, Policybazaar.com. Jain’s recommendation aligns very well with the compulsory annuitisation rule in pension plans and the NPS. At the time of maturity, at least 33% of the corpus of a pension plan (40% in case of NPS) has to be put in an annuity to earn a monthly pension. This compulsory annuitisation rule is what keeps many investors away from the NPS, but the Pension Fund Regulatory and Development Authority (PFRDA) believes it is necessary. “The compulsory annuitisation rule actually benefits the investor. It ensures that the investor gets some income on a regular basis during his retirement,” says PFRDA Chairman Deepak Mohanty.
How much can Rs.10 lakh investment give per month?
Outliving the nest egg
How long will your retirement savings last?
RISHI PIPARAIYA, FINANCIAL MENTOR AND AUTHOR
“Annuities are a powerful product. They give peace of mind by providing a regular pension when other streams of income have stopped.”
Can annuities beat inflation?
The other challenge before retirees is the unrelenting march of inflation. Unlike salaried people, who see their incomes rise every year, retirees have to make do with a fixed amount, even as prices of goods and services keep going up. In five years, even a nominal 6% inflation will reduce the purchasing power of Rs.1 lakh to Rs.73,390. In 10 years, it will be nearly halved. To counter this, annuity providers offer an option, where the pension amount rises 3-5% every year. However, the pension amount is low compared to a fixed amount till death. Also, the increase in pension is a simple increase and not compounded.
This means the hike in pension will be able to counter inflation in the initial years, but won’t be very effective after 10-12 years. Some people don’t like annuities because they take away liquidity. It’s a one-way street, and once you buy an annuity, it cannot be surrendered or changed. However, some experts feel that this is not such a bad idea, especially if the investor is not disciplined in money matters or financially savvy. “Even if one is disciplined, the spouse may not be able to handle money after his death. In such a case, an annuity is beneficial,” says Shah of Getting You Rich.
JAYANT PAI, HEAD OF MARKETING,PPFAS MUTUAL FUND
“An annuity is a tradeoff between high returns with fluctuation and relatively low returns with certainty.”
Inflation erodes annuity value
Here’s how 6% inflation impacts the purchasing power of Rs.1lakh.
He says that nine out of 10 annuity buyers opt for the joint life option that also covers the spouse. Indian parents like to leave something behind for their children. This is why many buyers opt for the return of principal option, where money is given to the nominee after the buyer and spouse die. However, this option gives lower pension than a regular annuity, where the payment stops after the deaths of the buyer and spouse.
VIVEK JAIN, HEAD, INVESTMENTS, POLICYBAZAAR.COM
“At least 40-50% of the retirement corpus should be allocated to annuities to provide an assured income to the buyer.” Source Link