The annuity problem

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Annuity has come to be a defining feature of retirement oriented investments. So, you have Pension Plans being pushed down your throats by insurance companies. One of the most debated investment options – NPS – too asks for a compulsory annuity of at least 40% of the final maturity value.

What does the annuity do?

Annuity is just another name of a pension. It allows you to receive a predefined cash flow on a regular basis.   

An annuity is typically offered by an insurance company such as LIC, HDFC Life, ICICI Pru, SBI Life, etc. You offer (or are forced to  in case of NPS & pension plans) funds to this company, which will provide you a fixed  pension/income on a regular basis.

The annuity amount is determined via a rate which the companies fix internally and can vary from one to the other.

Here are some of the annuity options that LIC offers:

  • Annuity payable for life at a uniform rate.
  • Annuity payable for 5, 10, 15 or 20 years certain and thereafter as long as the annuitant is alive.
  • Annuity for life with return of purchase price on death of the annuitant.
  • Annuity payable for life increasing at a simple rate of 3% p.a.
  • Annuity for life with a provision of 50% of the annuity payable to spouse during his/her lifetime on death of the annuitant.
  • Annuity for life with a provision of 100% of the annuity payable to spouse during his/her lifetime on death of the annuitant.
  • Annuity for life with a provision of 100% of the annuity payable to spouse during his/ her life time on death of annuitant. The purchase price will be returned on the death of last survivor.

Today the annuity rates are somewhere around 7%. The rate is locked in for the annuity period you choose.

This means that if you deposit Rs. 10 lakh into your annuity account, you will get Rs. 70,000 per year as your annuity income.

“So, what’s the problem? Isn’t it great to have a fixed income?”, you ask. 

Yes, of course, it is nice to have income coming to you regularly. However, annuity ignores a problem.

It ignores the devil in our lives – inflation.

If your annuity rate is at 7% but if your expenses grow even at just 5%, you will soon be staring at a deficit. See the table below.

Annuity vs inflation

You are getting a simple rate of return, but your inflation is compounding the costs every year.

Where do you get the extra money from to fund your expenses, lifestyle?

Will you reduce your consumption over time? Quite unlikely.

Mind you, I am not even talking taxes, which can reduce your income further.

Have you checked out the retirement fund calculator?

So, who should buy an annuity?

Clearly, annuity as a product is not for everyone. Even for those in their post retirement phase.

However, on a case to case basis, it may find a place in a financial plan.

I would venture to say that you can go for an annuity today, if

  • You are getting an annuity rate of 9%+
  • You need an assured income (as a retiree or otherwise)
  • You are not looking for capital appreciation or growth (you have enough money and security is more important to you)
  • You may not even be concerned about return of invested money.
  • You are in lower tax brackets

Almost makes it impossible!


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