Many investors tend to get a pension plan from an insurance company for converting their nest eggs into regular income for their sunset years. Some would be thinking to buy a pension plan for their retirement years. Unfortunately, they prey to fall into the trap of the “guaranteed pension for life” without realising that these plan offer very low returns, tax-inefficient, hamper liquidity by locking up their money forever and several flaws benefits that, combined with ridiculous rates from some insurers, it may become headache for your rainy days. One of the biggest challenges that retirees have to face a compulsorily buying an annuity at least of 2/3rd of their corpus to make their monthly, quarterly, half yearly or annual withdrawal. In India, annuity rates are already perhaps absurd and pathetic. Even, most life insurers do not indicate annuity rates online. Perhaps, they are trying to hide their pathetically low rates from the world. Even a loan is not possible against an annuity product. Since annuity products lock up your capital, you may feel cheated in it, if you have not understood the product correctly. In this post, you would know that how all annuity products are tied you up forever and you will not be able to see your principal in your lifetime.
Return of Purchase Price
Mostly pension plans offer the option of a single life or joint life with ‘return of purchase price’ and ‘no return of purchase price’ is something which may suitable to only those who have no legal heirs to leave their money after their death. Though insurers appear to offer higher annuity rates if you wish go to with ‘no return of purchase price’, they may not clearly declare ‘no return of purchase price’. However, they may offer you higher annuity rate 9-10% p.a. age up to 60 years which you may not get it today on a bank FD, but such rates may be available in future. A person with no legal heir may still need access to the money for healthcare or other emergency requirements as just getting a market rate of interest will not be enough at all times. If there is no legal heir, it is even more important to have liquidity as it means there is no one to take care of you. Remember that annuity with ‘no return of purchase price’ should never choose option as death any time after policy purchase will mean forfeiture of the investment by the insurance company. So, if you die soon after buying the annuity, the insurer gets a windfall. Even if you live longer, the rates offered by insurers are such that they will make a profit by keeping your investment amount. On the other hand, the chances of your not living too long are higher which is what prompts the insurer to offer more than the market interest rate. Instead of the insurer getting hold of your investment after your death with ‘no return of purchase price’, you might as well donate your money to a good NGO, in case you do not have legal heirs or do not wish to pass it on to them.
Deferred or Immediate Annuity
Pension products offer deferred annuity i.e. after accumulation phase or immediate annuity i.e. no accumulation phase. In an immediate annuity option starts giving returns from the very first month, or it could be a deferred annuity, which starts paying after a certain period. On completion of the accumulation phase of a pension product, you are allowed to take 1/3rd of the corpus as tax-free while 2/3rd corpus will be used to buy annuity. Since pension products from life insurers are big traps, you need to stay away. The IRDAI guidelines of December 2011 mandate that “All pension products shall have an explicitly defined assured benefit that is applicable on death, on surrender and on vesting (end of accumulation phase) which is disclosed at the time of sale.”
In short, the insurer has to only guarantee non-zero returns at the end of the accumulation phase. How does non-zero returns guarantee help the customer in any way if the policy offers a pittance like 1%? Non-zero returns guarantee also prevents insurers from offering high equity exposure just to be able to comply with the ‘guarantee’. So, getting a decent corpus from accumulation phase of pension product is difficult to achieve which makes pension products unattractive. Hence, choosing immediate annuity option is good deal as the Union Budget of 2016 has proposed to reduce service-tax on single-premium immediate annuity plans from 3.5% to 1.4% of the premium charged. If you buy annuity with a purchase price of Rs10 lakh, Rs35,000 used to be deducted as service-tax. It drops the net yield from the measly annuities rate even further. The proposed change would reduce the service-tax to be Rs14,000. When you are used to seeing the full investment going into our bank FDs, tax-free/taxable bonds, debt mutual fund, etc, you will wince at seeing even 1.4% deducted from your investment. After all, it is your hard-earned money invested for retirement planning.
In nutshell, while choosing any annuity products, you should know flurry of deadly features of that flawed product.
- No liquidity until dies, as there is usually no surrender feature. Some insurers may return your investment, if there is a specified critical illness or if you are able to show high financial distress.
- Offers lower rate than even the already low current interest rates on fixed deposits (FDs). Annuity rates are usually not revised in tandem with FD rates when they are high.
- Annuity income is taxable like bank FDs.
- You cannot take a loan against it.
- Service-tax is deducted on initial investment, which reduces your investment; hence, you start off without getting benefit on the full amount invested, unlike on bank FDs.
- Some insurers offer absurdly low rates.
- Sinister rule from Insurance Regulatory and Development Authority of India (IRDAI) that the corpus of a pension product needs to be invested with the same insurer for an annuity product, which gives insurers a captive customer sucked into a low rate annuity product.
Conclusion
Until all this happens, weigh the sense of satisfaction of getting ‘guaranteed income’ for life against the tax you will pay, low rates of annuity, lock-in for lifetime, no loan, etc. If the product were really good, it would fly off the shelf like tax-free bonds. If you had already taken any pension plan from any insurance company, it becomes like a chewing gum for you, which your could neither swallow, nor throw out, you have to just chewy. If you surrender a pension product any time before maturity, it will mean that you will have to give back a tax deduction you had claimed in the previous years under section 80C. The surrender value has to be added to your income and taxed as per your slab in the year of surrender. Save your life from it and keep yourself free from life insurers except for buying term plans. There are better ways to plan for retirement. Meet your financial planner or Investment Advisor today!
PS: This post got published at Hindi Dainik Bhaskar on 05-07-2016
Suresh Kumar Narula is founder and Principal Financial Planner at Prudent Financial Planners. He has earned the professional CERITIFIED FINANCIAL PLANNER and got registered with SEBI as Investment Advisor. He writes on personal and financial planning articles and got published in Dainik Bhaskar, Business Bhaskar and The Financial Planner’s Guild, India. He is also a member of Financial Planner’s Guild India ( An association of practicing SEBI registered Investment advisers) to create awareness about Financial Planning in general public, promote professional excellence and ensure high quality practice standards. Suresh received his an M.com from Himachal Pardesh University and an MFC from Punjab University, Chandigarh. He can be reached at info@prudentfp.in