Creating the “pensioned society” that Finance Minister Arun Jaitley wants is tough because we have annuities that suck. In an inflation-prone country, investing in the annuities now on offer makes little sense.
An annuity is a financial product that guarantees a monthly payout – almost like income – from retirement to death. (It is available even for people who just want an annuity by investing a large sum in one go). However, annuities suffer from two drawbacks – they are taxable, and after inflation, their real value keeps dropping the longer you live. In short, you get less and less real income with every passing year, thanks to inflation.
Currently, seven types of annuities are offered by Life Insurance Corporation (LIC) and other annuity vendors, and most of them suck. The returns are often lower than what an annuitant would get if she had the freedom to invest elsewhere. But current pension plans like the National Pension Scheme do not give you that freedom. Exiting from the National Pension Scheme (NPS) at 60 means accepting a declining real monthly pension.
Consider the broad schemes on offer.
One, the annuity is payable for life at a uniform rate. This is the annuity that offers the highest monthly payout (9.1 percent, according to a Mint compilation), but this annuity stops if you die early. You lose the entire corpus. No one in his right mind, unless you know for sure you will live long, will find the courage to take this bet. (All numbers in this article are from Mint).
Two, the annuity is payable for 5, 10, 15 or 20 years, and thereafter as long as the annuitant is alive. In this case, the insurance company pays a fixed guaranteed annuity of 8.5-8.75 percent, for terms of 15-20 years, and will continue that till death. Even if you die after five years, a nominee will get it for the remainder tenure. This scheme is better than the first, but you get slightly lower rates. And, of course, there is no inflation-proofing.
Three, this is a variant to scheme one, where there is an annual increase of 3 percent in annuity payments, obviously to compensate for inflation, but this scheme has the same drawback as the first one: it stops at death, and early death means loss of the corpus. And the annuity rate falls drastically.
Four, there are two other variants, where annuities are paid till death, and the invested corpus returned after that. But these have the lowest annuity rates. In one variant, the corpus is returned to the nominee after the death of the annuitant; in another, the spouse/nominee continues receiving the annuity, and the corpus paid to a third nominee. These yield rates of approximately 7.3-7.8 percent.
The simple takeout is obvious: the highest returns are where you agree to forfeit your corpus on death, and the lowest when the insuring company agrees to return the invested capital after death.
The Mint article gives out post-tax returns in the range of 5.04-6.29 percent, with the highest level given for the least-popular option – one where you lose the investment corpus completely on death. If you die early, too bad.
Now consider what you could do with the money if you could invest it yourself.
The Senior Citizens’ Savings Scheme offers 8.6 percent pre-tax, and you get your money back at the end of the tenure. You stay in control of your money, and there is the possibility of getting higher rates at another time. There is, of course, the problem of finding investment avenues after every investment period.
The bank fixed deposit offers 8 percent pre-tax (for senior citizens) – higher than the 7.3-7.9 percent offered by the best annuity schemes which return you invested capital on death).
Tax-free bonds of long tenures offer post-tax yields of 6.3-6.9 percent), higher even than the best returns on annuities.
If you manage your own post-retirement investment, you get flexibility to split your investment between fixed income and growth schemes of mutual funds, where you can hope to make additional incomes from long-term equity schemes with zero tax.
The annuities available are simply not the best you can get. You can’t have a pensioned society with poor annuities.
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