Sunday, 5 June 2016

Annuity Plans: Is It A Good Investment Option?

Annuity Plans is a financial product offered by the Insurance Companies in India which provides regular income to the Annuitant (Annuity Purchaser) on payment a certain sum upfront (either in lumpsum or in installments). It is primarily a pension plan which ensures that Individual don’t run out of financial resources post their retirement and also provides additional cover just in case they outlive their savings.
Annuity Plans aim at providing financial security when the earning potential has shrunk and one needs resources to sustain themselves and their dependents. Hence, Insurance Companies offer Annuity Plans which provide periodic payments which is a kind of pension/income to meet one’s expenses. However, despite the plan sounding so good theoretically it is not the same in the reality. Majority of the Personal Finance experts are never in favour of Annuity Plans and they have strong arguments for the same. Annuity plans suffers from numerous shortcomings which does make it a poor investment option.

Annuity Retirement Plans: Types and Benefits

Why Annuity Plans are not the Best?

Major Drawbacks:
  •            Lack of Liquidity, Blocking of Capital.
  •           Poor Returns on Investment
  •           Incidence of Tax
  •          No Consideration for Inflationary Trends

Annuity Plans have always lured the investors as they look for safe investment option and are hesitant to venture out of their comfort zone. It is widely observed that Investors often fail analyze a product and it is also the reluctance to take risk which drives them to take a defensive approach. Investment is Annuity is secure and peace of getting guaranteed pension for rest of the life is enough for many to purchase it.
However, apart from Guaranteed Income there is nothing much to write about the Annuity Plans. Return offered under Annuity plan is very poor and is tax inefficient. Moreover, there is no maturity benefit. Under Return of Corpus option, the Annuitant receives the Guaranteed Income till s/he is alive and on death the Annuity Purchase price is returned to the nominee. But the annuity payout is further reduced by 1%-2% resulting in even poorer return. To make matter worse the entire fund used to purchase Annuity gets blocked for life.

Rates offered by Banks on Fixed Deposits are comparatively higher and on completion of term entire capital is returned back. The Senior Citizen Scheme launched by the government provides decent return on the Investment for 5 year tenure.
Service Tax (ST) levied on Annuity Plans further dents the return. As currently 1.4% ST is levied on the Single Premium Annuity Purchase price. Even the Annuity Payout is not exempted from tax and is fully taxable in the hands of the Annuitant. Thus the Annuity Plans are not recommended by Financial Advisors and Tax Experts.
Any Pension Plan offered by the Life Insurance Companies mandatorily requires the Policyholder to invest 2/3rd (67%) of the maturity proceeds in the Annuity Plan of the respective Insurance Company. This further restricts the option available with the policyholder.

Return on Investment

The return on investment under Annuity Plans is pretty meager to say the least. Let’s compare the returns offered by various Insurance Companies under Annuity Plan.

*This is an illustration of a yearly annuity payout which an Annuitant is likely to receive against purchase of an Annuity Plan for Rs 1lac at the age of 60 years. Only Annuity for Life with Return of Corpus (ROC) on death of the Annuitant option has been taken for consideration.

Annuity Payout
SBI Annuity Plus
LIC Jeevan Akshay
*This is just an approximation used from respective portals. Actual Payout may differ by (±) 1%.

The return on investment is fairly low. Pure Annuity Plans with no benefit paid on death offer returns between 8.5%-9.35%. But rates fall drastically to 6.5%-7.2% under Return of Purchase Price to nominee plan. If you take inflation into consideration this return will cut a sorry figure. Another popular Annuity Payout option is with annual increment of 3% or 5% as the terms may be, but in this too the initial payout is very low.

Why Annuity Plans Still Survive?

Despite all its shortcomings Annuity Plans is very much in business and many individuals prefer it over other investment alternatives. Primary reason for doing so is the luxury of having Guaranteed Fixed Income for life which is favored by many as it eliminates any market or reinvestment risk which exists with other Investments.
Lack of high yield long term investment alternatives further strengthen the cause of Annuity Plans. Bank Fixed Deposits is available for maximum of 10 years tenure, after which Individuals have to reinvest the fund which carries a risk of getting low interest depending on market scenario.
No other Investment option provides such steady income over a long tenure. Thus it makes annuity plan a popular investment option.

Why Annuity Plans Returns Are Low?

Annuity Plans provide Guaranteed Income for life which means even if the interest rate falls down in the future Insurers cannot adjust the Annuity Payouts accordingly. Thereby, providing higher returns over such a long period is risky for the insurers. Moreover, Short term interest rates are higher than long term interest rates.
The Long term investment in Government Bond yields very low returns making it difficult for Annuity providers to provide high long term returns. Corporate Bonds for long term do yield better returns but are not always available.

Alternatives Available with Investors

Investors who want to earn better returns should be looking beyond Annuity Plans. The best alternative for Individuals above 60 years is the Senior Citizen Savings Scheme which provides a return of 8.6% for 5 years along with better liquidity.
Bank Fixed Deposits and Corporate Fixed Deposits also provide good return on investment. Senior Citizens are likely to get additional higher rate of interest on their investment.

Investment in Annuity plans is good if you are looking for a safe investment with no reinvestment risk involved and Guaranteed Income for next 20-30 years. But if one is looking for better returns and prefers more liquidity with funds then he/she should consider other investment alternatives available.

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