Debt Fund vs Annuity - Which is better?
Hopefully our earlier article would have given you a good idea on what annuity is and how does it impact your retirement income.
An annuity is preferred by retirees because it provides a sense of security that they will continue to receive money each month for the rest of their life. One may choose to receive fixed payouts at intervals (monthly, quarterly, half-yearly or annually) that suits them best.
However, as we explain in the next sections, there are several shortcomings to annuity schemes and investors are better off by investing in debt funds.
We have made a comparison study of immediate annuity and debt mutual funds. For the analysis of annuity, we have chosen 6 immediate annuity plans as shown in the below figure.
To make the calculations simple we have chosen the option “Life annuity with purchase price return” to analyse the returns provided by the above insurance companies.We have analysed this for a person of 60 years old wants to invest Rs 5,00,000 in an immediate annuity plan. We assume that the person will live for 20 more years. The following table shows the premium paid by the person and the annuity received by him for twenty years.
From the above table we can see that the internal rate of return (IRR) varies a lot based on the fund, from 4.23% - 6.44%. It is thus important that the fund returns are analysed before investing in an annuity plan.
Why debt funds? Debt funds typically invest in highly rated corporate and government bonds. There are a variety of debt funds to choose from, so the underlying corpus can be invested in funds that have a potential to offer a rate of return of between 7 to 9% which is higher as compared to annuity plans. The returns from some debt fund is given below:
The differences between an annuity scheme and a debt fund is summarized below:
It is important to note that Annuities do not provide any life insurance cover. Instead they offer a guaranteed income either for life or for a stipulated duration. They are specifically designed to protect individuals against the risk that they may outlive their own resources.
However, the major drawback of buying an annuity plan is the unattractive rate of returns. The returns are even lower when they are accounted for taxation. Also, annuities once started cannot be stopped, which can be a big handicap when a person wants to access their principal for some exigency. Hence due to investment in annuities access to principal is lost.
For a person who has retired, the need to access a large source of capital for emergencies cannot be understated and Annuities do not provide for such an option.
Due to these limitations we are not convinced that one should invest a large portion of one’s capital in an annuity plan. We would recommend a retiree to invest in debt funds to maintain a similar lifestyle considering the tax and liquidity benefits even after retirement.
Through investments in debt funds the above limitations of annuities can be removed. From our earlier analysis on debt funds, we reiterate the points below:
1) By opting for a systematic withdrawal plan in a debt mutual fund, investors can withdraw a pre-fixed amount from a scheme at regular intervals. SWPs are flexible and can be stopped whenever required.
2) The gains from debt fund schemes are considered long-term after 36 months. Long-term capital gains are taxed at 20 per cent with indexation. Indexation takes into account inflation during the period that the investment is held by investor and accordingly adjusts the buying price. This can lower the capital gains tax significantly.
Hopefully the above article gives a good idea to you the advantages and disadvantages of a debt fund vs an annuity.
Do write to us in case of any queries.
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