After slogging through yet another financial year ending work schedule, two employees discuss retirement funding plans and the advantages of a deferred annuity plan.
Inder: Another year end has passed, another year closer to golden years where the only mandate will be to sit back and relax. I have set my sights on building a generous savings plan for myself. But two terms caught me off guard where I need your help: deferred versus immediate annuity.
Dhruv: Well, savings or annuity products work by taking a sum of money from the policyholder, investing the amount and then providing a guaranteed periodic income from the fund, till a certain age or until death. Immediate annuity plans take the amount and start income payments from the first year itself. Deferred plans start income after a lag of 5 to 12 years.
Inder: Other than when the income starts, are there big differences between the plans?
Dhruv: Compounding is the big difference. In a deferred plan, the fund gets to compound itself over 5 to 12 years before income starts deflating the fund. With the same corpus, a deferred plan can thus generate a higher income stream compared to an immediate annuity plan since it compounds the undisturbed corpus for a longer time. The same compounding logic also applies to the bonus distributions that the insurer pays (on discretion) from his profit pool. This profit pool also gets larger in a deferred plan and hence both income and bonus will be higher.
Inder: But what about the time when there will be no income?
Dhruv: Well, you have to time it for your needs, that is the trade-off in immediate or deferred plans. Suppose you are set to retire in 12 years, you can start a deferred plan now. But if you realise the need for annuities on the day of retirement, then you will be left with immediate annuity plan alone.
Inder: That’s a lot of planning in a deferred annuity
Dhruv: Yes, and that is what is appealing to a section of policyholders. There is a clear goal to have a certain income by a certain age, which will need a certain amount to be paid upfront 5 to 12 years before. One can also plan to raise the initial corpus with a clear plan, avoiding significant chunk of uncertainty.
Through this plan, policyholders looking to avoid even minimum risk can lock in their financial itinerary for the next 15-20 years and that is what is sought after by investors in such plans.
Inder: Yes and that is what retirement should look like, rather than maximising returns in the golden years.