Annuity - Is it a good retirement investment?
Recently we received a few questions on annuities and many expressed an intent to invest in Annuities. We are writing this article to give a brief introduction about annuities and why they may not be the best option for you as a retiree.
Annuities – A brief introduction:
A typical annuity scheme requires the investor to make an investment into a scheme which will then provide a fixed monthly income after retirement until the scheme holder’s death.
Investors can typically choose from the below payout options of an annuity scheme:
- · Annuity Payable for Life: The retiree receives a fixed income paid at regular intervals throughout the insured’s life. This income automatically stops on the annuitant’s death. Please note that there is no return of the premium paid.
- · Annuity Payable for Life with a Guaranteed Period: The annuity is paid for a certain period and thereafter till the annuitant is alive. The shorter the guarantee period, the higher the fixed income paid in the scheme. The annuity stops on the later of the guaranty period or the death of the annuitant.
- · Life Annuity with Purchase Price Return: The pension is paid till the annuitant dies. After the death of annuitant, the purchase price will be given to the nominee.
- · Increasing Annuity at a fixed rate: The annuity paid increases each year with this option.
- · Joint life and last survivor annuity: Annuitant will receive pension till death. If the annuitant’s spouse survives then the spouse is also entitled to the pension. The considerable amount of pension to be paid to the spouse can be selected. Typically plans give an option for either 100% or 50% of the annuity to be paid to the spouse after the annuitant’s death.
Case Study: LIC Jeevan Akshay Plan VI
We have made a comparison study of annuity options provided by LIC Jeevan Akshay Plan VI.
LIC Jeevan Akshay Plan VI is an immediate annuity plan by the Life Insurance Corporation of India (LIC). An investor can buy Jeevan Akshay Plan VI by making payment of the lump sum amount. It offers annuity payouts immediately after the payment of the premium for a financially secured life after the retirement. LIC Jeevan Akshay Plan VI also offers a stated amount during the lifetime of an annuitant. The scheme offers the above mentioned options for investors and we have analysed each scheme’s return.
We have analysed this for a person of 60 years old who wants to invest Rs 1,00,000 in an annuity plan. We have calculated the return (IRR) the investor would earn assuming that the person will live until the age of 70, 80, 90 or 100 years.
Please note that the below returns have not been adjusted for any taxes payable by the investor. The Annuity received is considered as income in the year it is received & taxed as per the slab of the investor.
From the above table we can see that the highest return is typically available from the option- Annuity payable for life. However, it is important to note that the returns are negative or below average if the person lives only till 70 years (except in the case of life annuity with purchase price return – where the returns are still not attractive).
Only should the person live until the age of 100, will the returns over a 40 year period look a respectable 8%. Although we all wish to live as long as possible, realistically the chances of us living up to 100 are low. The breakeven age where an investor will earn a reasonable return (i.e. around 6%) is at the age of 85 years should he choose the scheme: Return of premium or Annuity payable for life. However, it should be noted that the investor is locked into this investment for at least 25 years and there is no option to redeem his Rs.1 Lakh premium at any point. For an investor in his/her retirement, this may not be a viable option as availability of funds in cases of medical emergencies is a necessity.
As a result, we do not recommend any of these schemes to our investors. We have analysed them to show that the returns are not attractive enough especially considering that one has to further pay tax on them and they are locked up for life.
There is one other option that we believe is more suitable if your goal is to achieve a steady state of returns post retirement. We think a Systematic Withdrawal Plan in debt funds is a much more attractive alternative and will recommend those to our investors. Please refer to our blog on debt funds for more details.
Please do let us know of your thoughts and if you have any questions.
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