Very often I meet personnel who are on the verge of retirement. During discussion I receive high number of queries regarding a good annuity product which can give them the fixed income for the life term. After doing lot of research I find it difficult to advise them because the investment required in any annuity product wrt their needs is way above their capacity. In fact most of them have already bought some annuity product which is not meeting even half of their retirement needs.
Hence it’s very important to understand annuities in detail and the actual benefits available to investors.
Firstly why product like annuities are required. Below is a transcript from one of the research on India which shows how longevity of Indian population of elderly’s is going to increase in coming years.
Age | 2031 | 2051 |
65 yrs+ | 8% | 13% |
65 yrs+ | 62.5 m | 229.4 mn |
The table above reflects the increase in Indian population who are above 65years of age. The research also points out that the life expectancy of an Indian person at 60 years of age has increased from 17.5yrs in 2001 to 19 yrs in 2006. This is expected to increase further especially for salaried middle and upper class that has access to superior education & health facilities. Lastly, across world population, it is expected that old age dependency ratio in Asia will equal US in coming years.
All of these figures indicate the need of a good post retirement income which can efficiently meet the requirements of the long life to be lived. Annuities, worldwide, has find favor with retirees as it is a product which not only suits salaried individuals, but self- employed professionals and business also find it helpful in meeting retirement risks.
What is Annuity
An annuity, in general term, is a fixed stream of payment for life term or for a pre-defined period. In insurance this is received through lump sum investment or by making regular contribution for a defined period. The main objective of annuity is to counter risk of longevity and to some extent, inflation.
Type of Annuities
There are two basic type of annuities designed in any insurance product:
1. Deferred Annuity: In this option, you build a corpus by investing regularly for fixed number of years. This corpus is then used to buy an annuity. All insurance companies pension plans are under this category.
2. Immediate Annuity: Here you purchase an annuity by paying a lump sum amount. The annuity starts from next month or within a year.
Payout Options
There are various options though which the company pays annuity to the investor. These options varies in the feature they provide and are chosen by the policyholder at vesting age i.e the age at which the annuity is to be started
a. Life time without return of purchase price: The annuity is paid lifetime and stops once the investor dies. The principal amount (purchase price) is retained by the company. The returns in this option are the highest and vary from 7.5 to 12%, depending at what age the annuity starts. Higher the starting age, higher are the returns.
b. Life time with return of purchase price: Here the annuity is paid lifetime to the investor and the purchase price is returned to the nominee after his/her death. The returns offered under this option are on lower side and varies from 4-7.5%.
c. Annuity guaranteed for certain period: Annuity is paid for a defined period, say 10 0r 20 years, irrespective of survival of policyholder. Beyond this, amount is paid only to the policyholder till he/she dies. Since it is a guaranteed payout you can expect return of 4-9% from this option.
d. Joint Annuity: Here, the spouse too gets the annuity for lifetime after the death of the investor. The return from this option range from 7-9.5%.
There are other options which have been launched by the companies like inflation adjusted and fixed increasing annuity. As seen above, the returns from all these options vary depending on the age at which the annuity starts and how long the insurer has committed to pay. The rate of return is generally fixed and assured for the lifetime but varies across companies and plans.
What is Available
There are two options available with life insurance companies for receiving annuity:
1. Pension Plans: These are accumulated products (Deferred annuity plans) where you invest regularly for a period (Vesting age) and with the corpus generated you receives the annuity. The policyholder has the option of choosing one of several annuity options available with insurance company. There are two type of pension plans offered by insurance companies- traditional and Unit linked. The returns vary in both the options since investment structure are different. The good feature with these pension plans is that they allow investors to choose the vesting age which generally starts at age 40.In pension plans, all insurance companies offer “ open market options” where the investor can take the corpus and shop around to purchase the best annuity product. These plans were very popular till IRDA stipulated minimum guaranteed return of 4.5% by insurers. Since then they have almost vanished as the companies find it unfeasible to generate such returns. IRDA is thinking again to bring some changes in the product.
2. Immediate Annuity Products: These are products which an investors looks around on reaching the vesting age. However, not many insurance companies offer immediate annuity product and the returns from existing ones have not been very attractive. LIC is the major player in this space along with 4-5 more companies from private sector who offer immediate annuity. With government focus on reducing burden of LIC from annuity products, you can expect offerings from more private players going forward.
Drawbacks of Annuity products in India
In India annuity products have not seen much of the success. Pension plans were bought heavily by investors but the decision was more from the tax saving perspective. The reasons are manifold which need to be addressed in order to make this a viable option. Given below are some of the reasons due to which annuity products have lost attraction among the investors:
1. Annuities are illiquid. Annuitants forfeit the option to liquidate and exit in case of unforeseen expenditure.
2. Generally, in fixed income assets, the basic principal is returned to the survivors if the investor dies. In annuity products, the option of leaving bequeath to the family is very limited and the cost an investor pay is too high.
3. Return from annuity products has been the major concern for the investors. The returns in the past have averaged 6%.The reason may relate to absence of long term investment avenues for companies but it does makes the investment unattractive for investors.
4. Pricing of annuity products also been a major issue. For all insurers the standard rates are the rates computed by LIC (96-98) which has now become almost unsuitable. Also, mortality rates for longevity predictions were calculated a decade ago. At that time the rates were similar across different population graph. This is now irrelevant as women lives are considered to be longer than male lives. Due to this reason the costs of annuity products have been on the higher side.
5. Inflation Risk- Most annuities provided in India are fixed for the term. Since inflation erodes the value of money, with increase in longevity, even a small increase compound the losses. Hence inflation adjusted annuities are need of the hour. Companies like SBI do have such option but 1-3% increase does not help in beating inflation.
Alternative Options
A five year fixed deposit is offering 10% with benefit under section 80C. PPF offers 8%, Senior Citizen Savings Scheme offers 9% and Post Office Monthly scheme offers 8%.The tenure of these schemes are limited starting from five years to 15 years. Also the amount of investment is limited in most of these options. Contrary to this annuities are for life time and there is no limit to amount of investment. However, the average return offered, taxability, flexibility and inflation make it unviable choice at present.
The annuity market in India is not yet developed. Absence of long term investment avenues for companies which can reduce their mismatch on asset liabilities and decade old predictions are the main reason for low returns from the product. Some annuities offer 8-9% at present but only with an option to retain the purchase price after the death of the annuitant. If they return the amount to the nominee, the return comes down to 4-7%. The annuity returns are higher for older people which means the longer you live the less you earn. For example in SBI life annuity products it gives 5.3% to a 50 year old and 6.7% to a 60 year old. If a 70 year old wants to buy annuity then it is 9.5%. All these are pre tax returns and on death the company retains the purchase price. In the return of purchase price the returns goes down.
Thus it’s very difficult for an individual to choose any annuity product when the returns are not market linked.
Hopefully, with development in pension sector and more focus on product structures, we will have good annuity products in coming years. As for now, someone who has reached age 70, it can form a part of your retirement income only if you are satisfied with low returns and the low flexibility they offer.
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