India seems to be on a mission to educate its investors (or so I am told!). Which is why I am surprised when all too often, newly retired professionals come to us with lengthy illustrations for annuity plans from Life Insurers, minds already half made up to purchase them. After all, what better than the lure of a fixed return with zero market risk, and none of the hassles that actively managing one's investments entail?
If you're recently retired and reading this story, I hope this short critique of annuity plans (as a whole) will help you evaluate these plans more clearly and take a more informed decision before you park your carefully saved retirement money into them. Do remember that surrender clauses for annuity plans are not very attractive, so look before you leap!
I will also consider the example of the seemingly ubiquitous LIC Jeevan Akshay, which in all fairness is one of the better performing annuity plans available today.
There are many variants of annuity plans - immediate, deferred, joint life, with return of premium, without return of premium, and so on. However - regardless of the variant, here's what's common to all these plans: in all likelihood, they will give you an annualized return of under 8 per cent (pre-tax). For a long term investment portfolio, that's very low indeed.
Annuities are simple and easy to understand; in fact, that's one of the great lures of the product. You pay a lump sum of money to the Life Insurer, who promptly starts making monthly, quarterly or annual payments to you (the more frequent the payout, the less you receive is a thumb rule). The payouts continue until you're alive, and that's quite possibly the only plus point in favour of annuities - the fact that they de-risk you against the prospect of living too long. However, there's a steep price to pay in the bargain.
For instance, if you've just retired at 60, LIC's Jeevan Akshay will pay you an approximate amount of Rs. 9.4 lakh per annum for a 1 Crore (plus 3.5 per cent service tax - which may be reduced to 1.5 per cent soon). Alternatively, you could choose the "return of premium" option, wherein your heirs will inherit the lump sum amount after you pass away (but that would come at a price - the annuity amount itself would fall to approximately Rs. 7 lakh per annum). Do also consider that Rs. 1 Crore, after 25 years, would be the inflation adjusted equivalent of Rs. 20 lakh today - so it's unlikely that your heirs will be doing cartwheels when they receive their cheques!
Does the above stated sound good to you? Actually, the premise of annuity plans is deeply flawed on three fronts.
Firstly, as a Financial Planner myself, I balk at the concept of your retirement corpus generating a fixed income in rupee terms for 25 years. Unless you plan to seriously live it up for the first 10 years and live as an impoverished soul for the next 15, you should instead opt for a plan that starts you off with a smaller monthly payout, inflating it by 7 per cent per annum as you go along. Yes, annuity plans have an option of increasing the annuity amount by a fixed yearly percentage (usually a pittance, closer to 3 per cent), but here's the fun part; put the illustration in a spreadsheet and BAM - sub 8 per cent returns again. It's magical - just not in a fairy land sort of way!
Secondly, the returns are poor. For LIC's Jeevan Akshay, a probable scenario (assuming a Life Expectancy of 85) indicates an annualized return of close to 7.6 per cent. Assuming that your daily vitamins and diligent fitness routines really pay off and you live till a hundred - you're still at an 8.7 per cent return (for a 40-year timeframe, this is beyond poor). And this is before taxes - annuities are taxable as normal income, mind you!
Thirdly, an annuity plan is a long term commitment. In other words, once you're in, you're in - it's really hard to exit and swap the plan for something else. How sure are you that absolutely NO better moderate risk bearing investment options will come up in the next 25 to 40 years?
So what's a retired person to do? Simple - follow a portfolio approach. Spread your money across asset classes - bonds, stocks and mutual funds with the aim of earning an annualized return of 10-12 per cent post taxes.
We no longer live in times where age or risk tolerance can be the sole determinant of asset allocation. Even retired people need to invest 10-20 per cent of their money into high growth assets - fret not, the long term holding period will greatly reduce the associated risks. Many mutual fund schemes follow a dynamic asset allocation approach based on market valuation indicators - you might want to park 20 per cent of your investments into these. A trusted, conflict free investment advisor can be very useful when it comes to helping you construct an appropriate portfolio.
If I was to retire tomorrow, I wouldn't buy an annuity - and neither should you.
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