Annuity As A Retirement Saviour
Dalal Street Investment Journal|May 10, 2021
Given the economically uncertain times that we now live in, most people prefer to embark on a sound investment plan at an early age to be able to generate a fixed income during their years of retirement. An annuity plan is one such option that locks your investment per month to be able to create a corpus which will pay back a regular amount each month on retirement. The article highlights the pros and cons of annuity plans while comparing them with other options

Anil Kapoor is a retired man now. Nonetheless, he had planned for his retirement during his heydays and has invested judiciously in both equity and debt to take care of his second innings. However, the recent heightened volatility in the equity market has made him a worried man. Bellwether equity indices are swinging by a couple of percentage points quite effortlessly. Even the much stable debt market is witnessing a rise in volatility of its benchmark yield. For someone who has invested for the long term, these uncertainties may not impact much but for a retiree like Kapoor, who depends upon his investment in these securities to withdraw his regular income, any such uncertainty can be unsettling.

He would rather have regular and guaranteed income in his golden years and such volatility may push him into sleepless nights. As in the case of Kapoor, if you are one of those looking for regular and guaranteed income in your sunset years, allocating a part of your retirement corpus to a suitable annuity product may be the answer. These products are specifically designed to meet long-term retirement needs. However, before diving deep into the details of annuity, let us first try to understand the product itself.

Annuity Plans

An annuity plan is mostly offered by insurance companies. After you pay a lump sum to an insurance company, it invests this amount and pays back the returns generated from it in the form of regular payment. Hence, annuity is a plan that helps you to get regular payment for life after making a lump sum investment. However, though annuity plans are offered by insurance companies, they do not cover your life under annuity in most of the cases. But you can select a product that offers both annuity and life cover. Post-retirement, the risk-taking ability of an investor declines significantly in the absence of regular income and in such a case annuities provide some relief.

Types of Annuities

Typically, any retirement strategy involves two stages. First is the accumulation phase and the second is the distribution phase. In the accumulation phase you save and invest for your retirement without withdrawing from it. Once you are retired, you start withdrawing from your corpus to meet your regular needs, which is known as the distribution phase. So, broadly speaking, annuities can be of two types depending upon when you buy them – deferred or immediate.

In the case of deferred annuity you first contribute towards your retirement corpus steadily when you are earning and once you retire, you can use the accumulated amount to buy an annuity plan. Most insurance companies enable you to build the corpus through a pension plan. When the tenure of the pension plan ends, you use the accumulated money to buy annuity. If at the accumulation stage you have invested in a pension plan from an insurance company, then it is compulsory to invest at least one-third of the amount that you get from this instrument in an annuity plan at the time of retirement. For example, consider the case of Arjun Sinha (35) who wants to retire at the age of 60. He has been investing ₹50,000 every year towards annuity i.e. about ₹4,133 per month. Assuming he earns 9 per cent every year on his investment, over the next 25 years his total investment would be around ₹12.5 lakhs. This investment would grow to ₹46.70 lakhs by the time he retires. If he buys annuity of this amount he will get monthly pension of ₹23,342 every month on retirement.

National Pension System (NPS)

India moved on to a defined contribution-based pension system in 2004 based on the recommendations of two committees. The New Pension Scheme, now renamed as National Pension System (NPS), is a pension system administered and regulated by the Pension Fund Regulatory and Development Authority (PFRDA), which was initiated with all government employees joining from January 1, 2004. The scheme was initially made compulsory for government employees, and then in 2009, opened on voluntary basis to the general public.

The scheme is portable across jobs and locations, with tax benefits under Section 80 C and Section 80 CCD. You are compulsorily required to keep aside at least 40 per cent of the corpus to receive a regular pension from a PFRDA-registered insurance firm. The remaining 60 per cent is tax-free now. The two primary account types under the NPS are Tier I and II. The former is a default account while the latter is voluntary addition. The table below explains the two account types in detail.

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