If you’re sick and tired of relatives, friends and neighbours badgering you to buy insurance, you may be surprised to know that there’s one type of insurance that’s hardly ever hard-sold to Indian investors. Immediate annuity plans are often ignored by agents because they require clients to sign up for an over-large upfront premium. Financial advisors shun them because of their modest returns and lack of tax efficiency.
But while immediate annuity plans are a much-hated product, they could be a good fit for some special categories of investors. One, retirees who are looking to lock into rock-steady pension for their lifetime with zero appetite for market or interest rate risks. Two, investors who are looking to set up a guaranteed stream of income for kin who aren’t financially savvy or unable to actively manage money – say a spouse, sibling or child with special needs. Three, investors who would like a bedrock of minimum income on which they can layer higher-return earning market instruments.
What are they?
Immediate annuity plans, despite their complex-sounding name, offer a simple deal — you pay a lumpsum amount to the insurer (called purchase price) when you sign up for the plan. The insurer, in turn, promises to pay you a regular income (called annuity) at yearly, half yearly, quarterly or monthly intervals for the rest of your life, starting immediately. Investors in the 30-90 age group can sign up for immediate annuity plans. Surrender or exit from such policies is often barred or carries stiff conditions.
But choosing a plan isn’t easy, because life insurers offer anywhere between five to fourteen variants of the basic annuity plan. Here they are.
#1 Life annuity (also called life annuity without return of purchase price) pays you a flat pension for the rest of your life. On your death, the pension will stop. Your dependants will not get back your purchase price.
# 2 Life annuity with escalation pays you an income that rises at a certain fixed rate every year. But the increases may not keep up with inflation because they tend to be modest at 3 or 5 per cent every year, and at a simple (not compound) rate.
# 3 Life annuity with return of purchase price pays you a pension for the rest of your life, with your nominees getting a refund of your purchase price. This is for folks who would like to leave their nominees a fat sum after death.
# 4 Life annuity with return of purchase price in parts pays a fixed pension and returns part of your capital to your nominees.
# 5 Life annuity with a guarantee period pays a flat income for a fixed number of years to you or your nominee, irrespective of whether you live. This is for folks who worry that their purchase price would be wasted if they die too soon.
# 6 Joint life annuity pays you or your nominee a certain income as long as either of you is alive.
Returns and taxation
While the biggest plus of immediate annuity plans is their ability to deliver guaranteed lifelong income, their biggest minus is their low effective returns which often make public sector bank FDs look good.
Insurers usually present the returns that they offer in their immediate annuity plans in the form of ‘annuity rates’. But the effective returns from annuity plans are better gauged by calculating an Internal Rate of Return (IRR).
Take the case of LIC’s Jeevan Shanti. A check on the LIC website in October 2019 reveals that a 60-year old investor who signs up for the plain vanilla annuity without return of purchase price will receive an annual income of Rs 90,942 for a Rs 10 lakh purchase price. This translates into an ‘annuity rate’ of 9 percent. This is simply calculated by dividing the annual income by purchase price and doesn’t account for the fact that this plan doesn’t return capital. The IRR on the plan for the 60-year old who lives on until 85, is 8 percent. Given that the annual annuity income is taxed at your slab rate, the post-tax returns would be at about 5.5 per cent at the 30 per cent slab.
The annuity rates offered by these plans can however be far lower depending on your age of entry and type of annuity you opt for. A 50-year old buying Jeevan Shanthi will have to make do with annuity of Rs 79,212 per Rs 10 lakh investment. If a 60-year old opts for an annuity for joint life with return of purchase price, she receives only Rs 67074 for a Rs 10 lakh purchase price. However, these rates do vary with the rate cycle and you can get higher rates if you time your entry to a high point in the rate cycle.
Financial advisors often shun annuity plans on account of their unfriendly taxation. The purchase price that you pay on an immediate annuity plan is exempt under Section 80CCC but gets clubbed with scores of other products which are subject to the overall 80C cap of Rs 1.5 lakh a year. The purchase price also attracts GST which can be a hefty outgo on the upfront payment. Most important, the income you receive from your annuity plan is taxable at your income tax slab rate. While bank deposits suffer similar taxation, retirement options such as debt mutual funds help you get away with a far lighter tax burden.
While post-tax returns of 5-6 per cent may appear to be modest in the current rate scenario, immediate annuity plans can pay off for you in two kinds of situations, in which other investments don’t do well. One, these plans reward you for longevity. The longer you live, the higher returns you stand to make from an annuity plan. Two, if interest rates in the Indian economy collapse to anaemic levels of 3 or 4 percent as they’ve done in the developed world, you’ll be on the velvet having locked into an annuity rate of 7 or 8 per cent.