Real Returns. All about annuities

Annuity plans are a much-maligned class of investments, thanks to their low returns, lack of tax benefits and complex product structure. But immediate annuity plans, which guarantee lifelong income at monthly, quarterly or annual intervals, are a good fit for investors who value certainty over everything else.

Immediate annuity plans are offered by the Life Insurance Corporation of India (LIC) and private sector life insurers, such as HDFC Life, ICICI Pru Life, SBI Life, Birla Sun Life and Reliance Life.

Immediate annuities are, at their root, a very simple product. You pay a ‘purchase price’ to the insurer in the form of a single premium. In return, the insurer pays you a guaranteed monthly, quarterly or annual income (the annuity) as long as you live.

Most insurers offer five to six variations of this simple annuity product. This is best explained with the real-life example of LIC’s immediate annuity plan Jeevan Akshay VI.

Purchase price: When signing up for your plan, you can choose either lifelong annuity with or without return of purchase price. Let’s assume you are 60, have just retired and can pay ₹10 lakh to purchase an annuity.

If you choose a lifelong annuity without return of purchase price, you will receive an annual payout of ₹93,500 (or monthly income of ₹7,450) for the rest of your life. The initial premium will never be returned.

But if you choose a plan with return of purchase price, you will receive a lower monthly income of about ₹5,660 for the rest of your life, with the ₹10 lakh repaid to your nominees upon your death.

Opting for the plan without return of purchase price is your best bet if your objective is to get maximum bang for your retirement buck. In any case, 25 years hence (assuming your life expectancy is 85), the value of that ₹10 lakh would be eroded by inflation and may not mean much to your heirs.

Increasing annuity: Apart from a fixed annuity, some insurers offer you the alternative of an increasing annuity, which rises by 3-5 per cent every year.

Investing ₹10 lakh in the 3 per cent increasing annuity from LIC for instance, will start you at a monthly income of about ₹6,000, which will rise by ₹180 every year. But while increasing annuity plans are intended to protect you from inflation, they do an ineffectual job of it.

The increase is not compounded and is calculated at simple rates. It is too small to really shield you against inflation. And such plans start you off at much lower income levels than non-increasing plans.

Joint or survivor: A third choice you will have to make is between a single annuity and a joint/or survivor annuity. If you have dependents in your family, such as your spouse, you can opt for a joint or survivor plan, where the surviving member will continue to be paid lifelong annuity, on death of one member.

A without return joint policy from LIC will fetch a monthly income of about ₹6,440 for a purchase price of ₹10 lakh.

Guaranteed returns in any investment product seldom come with high returns, and immediate annuity plans are a prime example of this. Illustrations from different insurers show that a purchase price of ₹1 lakh at 60 can yield you annual income of ₹6,700-9,350, without return of purchase price.

That’s an effective annual return (IRR) of 5-8 per cent, assuming you avail of the income for 25 years. Clearly, to set up a respectable monthly income of ₹50,000-60,000, you will have to shell out a sizeable ₹50-60 lakh upfront.

The income you receive as annuity is fully taxable at your income tax slab rate too.

However, having said this, you can maximise your annuity returns in four ways. One, lock into your annuity plan when interest rates are at a high as they are now.

Annuity rates of insurers are based on the yields of long-term government securities and rise or fall in line with interest rates in the economy.

Two, opt for the basic plan without return of purchase price. You can always use other investment products to accumulate a corpus for your heirs.

Three, most insurers offer discounts of 1-3 per cent for purchase prices of over ₹2.5 lakh.

Therefore, resist the temptation to buy multiple annuity plans and plumb for a single insurer. Four, among the insurers, LIC’s Jeevan Akshay VI currently offers the best return (annual income of ₹9,350 for ₹1 lakh). Go for other products only if they manage to top that.

Finally, as annuity plans are truly long term and you will rely on them for your basic income, ensure you buy them only from insurers with a 10-year track record in the Indian market.

The above analysis should tell you that immediate annuity plans are not ideal for investors who seek high returns or liquidity. But they can still be a good bet for risk-averse investors who want to lock into a basic income for 20 or 30 years.

Just consider the other monthly income options available to a retiree today. Bank or NBFC deposits offer monthly payouts, but allow you to invest only for five year at a time.

The same holds true for the Senior Citizens Savings Scheme too, despite its high return of 9.3 per cent.

At the end of five years, if interest rates in the economy fall, your income will take a hit too.

Debt mutual funds or Monthly Income Plans may deliver better returns with anytime liquidity, but carry market risks. Annuity plans are the only long-term option with completely predictable returns.