‘Why annuity makes sense for retired individuals to generate regular income’

Considering the declining interest rate scenario, many retired and people nearing retirement are looking for generating regular income that can beat inflation. The simplistic but not-so-optimum method is to park the money in bank deposits and withdraw as and when required. A better way is to invest in mutual funds and do a systematic withdrawal plan (SWP).

There are ‘pension plans’ floated by AMCs but they do not provide pension per se. These plans are for building up the corpus over a long period of time and use the accumulated savings in the sunset years.

This is where annuity fits well to generate regular income. Your clients can invest the corpus with an insurance company and receive the annuity as long as they or their spouse live. In this article, we will discuss about annuity.

Immediate and deferred annuity

If your client is at say age 60, has a corpus of say Rs.1 crore and wants the annuity to start without any delay, he should go for an immediate annuity. On the other hand, if your client is say age 50 or 55 and still earning, he can invest Rs.1 crore in deferred annuity where the annuity starts after a deferment period of say 5 or 10 years. In the deferment period, the corpus grows with the insurance company from their investments in the market. In exchange for the deferment period and growth of the corpus, they will reward you with a higher payout than immediate annuity.

Illustration of annuity

Reading the table

In the first row, a 60-year old female client buys an annuity with a purchase price of Rs 1 crore including taxes. This is an immediate annuity given that the deferment period is zero.  In the first scenario, she will receive annual payout of Rs.5.54 lakh. However, if she would have bought differed annuity (row 4), she would have received higher payout annually.

While deferred annuity gives higher payout, it is advisable to opt for such option till a client attains the age of 65. It makes more sense to go for immediate annuity if a client is older due to reduced life expectancy.

Single or joint?

Annuity can be purchased for individual or jointly with spouse. The advantage of purchasing it jointly is that if your spouse outlives you, she or he will continue to receive the annuity till he/she survives. That way, you can purchase peace of mind in terms of the regular income.

Liquidity

While it is possible to surrender annuity, many insurance companies impose high surrender charges.

Conclusion

While annuity gives your clients peace of mind in terms of regular income for life, the payout is taxable in the hands of investors depending on their tax slab.

Overall, the main advantage of annuity is that it covers longevity risk i.e. risk of living longer. Other retirement options offer  finite sum of money but annuity secures the entire life. Also, since it is advisable to go for annuity with return of purchase price, your clients can leave a legacy for their loved ones. Please note the return difference between regular annuity and annuity with return of purchase price is not so substantial. In most cases, it is less than 60 bps.

Deepak Jaggi is Co-founder and Managing Director at Satco Wealth Managers. He can be reached on deepak.jaggi@satcowealth.com.

The views expressed in this article are solely of the author and do not necessarily reflect the views of Cafemutual.