Decoding annuity options in NPS

The National Pension System (NPS) has become one of the preferred retirement options in India, thanks to its low cost structure, transparency, hassle free operation, better performing fund options and tax advantage. The Centre made NPS available to new entrants in Central Government services, with the exception of Armed Forces, with effect from January 1, 2004. Most of the State governments have also followed suit. While the all citizen model was introduced from May 1, 2009 for individuals volunteering to join NPS, a full-fledged corporate model took off from December 2011.

Through NPS, you accumulate a retirement corpus in your working life, part of which can be withdrawn as lumpsum while exiting from the scheme, while annuity has to be purchased from the other part. Since the Central Government employees (who joined service after January 1, 2004) are entering the 15th year of accumulation phase in NPS and many others might have completed the 10th year, some could be wondering what happens to their money once the accumulation phase ends.

According to industry source, over 18,000 NPS subscribers have moved into annuity phase so far. As on December 2017, the total number of NPS subscribers stood at 1.92 crore.

Here’s decoding the annuity options available to NPS subscribers to help you zero-in on the right option.

NPS has no role post-exit

With a wide range of investment options and choice of pension fund managers, the NPS helps subscribers accumulate a healthy retirement corpus during their working life.

Once the subscriber reaches the age of 60 or on attaining superannuation or at premature-exit, the NPS allows the subscriber to exit completely — by enabling withdrawal of the lumpsum and transferring the balance to the annuity service provider (ASP).

NPS has no role to play apart from transferring your accumulated corpus to the ASP.

The subscriber has to identify the ASP from which he wants to purchase annuity. The annuity service providers, appointed by PFRDA, are life insurance companies responsible for delivering a regular pension (annuity) to the subscriber for the rest of his life.

Currently, seven life insurance companies — LIC, HDFC Life, Bajaj Allianz Life Insurance, ICICI Pru Life Insurance, SBI Life, Star Union Dai-Ichi Life and Reliance Nippon Life Insurance — have been appointed as annuity service providers.

Annuity is mandatory

As per the current regulation, the NPS has mandated that a portion of the accumulated corpus should be utilised to purchase annuity, depending on the conditions of the exit.

On exit from NPS upon normal superannuation, at least 40 per cent of the accumulated pension wealth of the subscriber has to be utilised for purchase of annuity. The balance 60 per cent is paid as lumpsum to the subscriber. This is applicable to all the government employees and subscribers under all citizens and corporate models.

On premature exit from NPS before the age of normal superannuation, at least 80 per cent of the accumulated pension wealth should be utilised for the purchase of annuity. The balance (maximum 20 per cent) is paid as a lumpsum to the subscriber. This is applicable to all government employees who have voluntarily resigned or have exited from employment before the age of 60. However, the subscribers under all citizen and corporate models should have subscribed to NPS for at least 10 years to take the premature exit route.

On death of the government service subscriber, at least 80 per cent of the accumulated wealth should be utilised for purchase of the annuity in the name of his spouse.

The options

Each annuity service provider offers anywhere from five to 14 variants of the annuity options on its menu. Since annuity is not so popular as an investment product in India, the regulator has instructed the insurers to pitch four main variants — 1) Annuity for life 2) Annuity for life with return of purchase price on death 3) Joint life, last survivor without return of purchase price and 4) Joint life, last survivor with return of purchase price.

There is also ‘NPS – Family Income’, a dedicated annuity option offered to government employees that ensures annuity for the subscriber through his life, then provides annuity to his spouse, then parents and, finally, also returns the purchase price to the nominee. Currently, IRDA (insurance regulator) has approved only SBI Life and ICICI Pru Life to sell this option to government employees.

Please note the returns from the annuity are relatively low compared to other conservative investments such as bank FD, senior citizen savings schemes and post office schemes. The striking feature of the annuity product is that the longer you live, better the returns earned. Annuities are suitable for retirees who seek a minimum level of monthly income with financial security and without having to monitor or micro-manage their portfolios.

Key features

of NPS

Frequency of annuities: Only monthly payment option is provided to the government sector subscribers now. However, the subscribers under all citizen and private sectors can choose any one of monthly, quarterly, half yearly or yearly payment frequencies.

Annuity option, once chosen cannot be changed. So the subscriber should be careful while selecting the right option.

Annuity payout is fixed at the inception of the policy and stays unchanged throughout the life, except in increasing annuity option.

Deferment of annuity: You can defer your annuity purchase by three years. However, this annuity deferment is applicable only upon reaching the retirement age of 60. Subscribers who entered NPS in the 60-65 age bracket can purchase annuity at the age of 65.

The annuity rates vary based on the age, purchase price and the option chosen.

Entry age: The earlier you purchase the annuity, lesser the pension you will get. For instance, a 60-year old subscriber investing ₹50 lakh in ‘annuity for life’ option of SBI Life, gets a monthly income of ₹35,703. If he defers the annuity purchase to the age of 63, his monthly income would be ₹38,016. Insurance companies offer higher rates to more elderly people as the probability of demise is higher.

Purchase price: For the higher purchase price, you may get better deals. In effect, the internal rate return (IRR) was 6.6 and 6.4 per cent for the ₹50 lakh and ₹3 lakh investments respectively in the ‘annuity for life option’ under HDFC Life, in which the payments were received for 20 years. Shopping around for good deals can bump up your monthly income significantly.

Lower pension in joint life : The pension income is lower if the pension is to be paid to your spouse too. For instance, as a 60-year old subscriber, the monthly income you receive from the LIC Life’s ‘Annuity for life’ for the ₹10 lakh investment is ₹7,275. But if you choose ‘joint life annuity’, then your monthly income goes lower to ₹6,267.

Periodic rate reset: The annuity providers reset the annuity rates periodically based on the prevailing interest rate in the market. The rate at the time the annuity is purchased is applicable to the future annuity pay-outs. So, if a subscriber purchases the annuity product when the interest rates are high, he may get higher annuity rates and vice-versa.

Taxation: The purchase price that you pay to buy an annuity plan is fully exempt from tax. Secondly, the purchase price of an annuity plan is subject to GST, which is taxed at 1.8 per cent. This can impact larger investments. For instance, ₹18,000 is charged as GST for the purchase price of ₹10 lakh. Thirdly, the regular income you receive from your annuity plan is taxable at your income tax slab rate. Here, the only solace is that you may fall in the lower tax brackets, post-retirement.

Low return: The rates provided by the annuities are relatively low. It is because the rates are set based on the long-term interest rates in the economy. The money received from the subscribers are invested in long term debt instruments from which obtaining higher yields is difficult. Currently, the annuity return rates are in the range of 6 to 6.6 per cent. Also, these rates are net of the expenses incurred by the insurers.

Not comparable to others: One cannot compare the annuity rates with other conservative investment options such as FDs, senior citizen savings schemes and post office schemes. The beauty of the annuity product is that the longer you live, the better your returns earn from it. Secondly, the annuity product with return on capital can be compared with FDs as you get back your capital. Though bank FDs and other post-office schemes score over NPS on returns, they carry re-investment risk.

Not inflation-beating: Under annuity, you may opt for return of capital option which may be tempting, but there is no point to it because the value of your capital — 20 or 30 years hence — will be quite low when adjusted for inflation. Instead of seeking a return of capital from your annuity plan, you can create a separate corpus, by investing the amounts withdrawn from the NPS, in inflation-beating instruments like a mutual fund, that you can pass on to your dependants.

Surrender: Annuity plans, in general, do not encourage surrender of the policies. However, they accept surrender in special circumstances such as shifting to another country permanently or in the event of certain critical illnesses. Annuity providers accept surrender only if you had selected the annuity option of ‘Return of Purchase Price’. Also you should have completed one year from the purchase of the plan to surrender it. Anyway, surrender charges are quite high at around 7-15 per cent of the purchase price.