How to choose the best annuity plan

Working individuals in their early stages of life are worried about building their retirement corpus and are constantly wondering how to accumulate more and more to make sure that their future is secure. On retirement, one does not have a regular flow of income, hence they seek to look out for options that will provide them with a regular flow of income. However, one must get an understanding about their monthly expenses, and based on that, after considering inflation, the corpus they require and the corpus that would be enough to last for their lifetime. According to that, one should choose to invest in products that will help them achieve financial freedom once they retire.

The fact that annuity plans give guaranteed returns for the rest of your life post retirement, make them a lucrative investment option to fulfill the post retirement needs. This gives investors a sense of security as they are getting a guaranteed pay-out and there is no risk of losing their capital. Although annuity plans carry certain benefits, this does not necessarily mean that these plans might be good for you. It is necessary that one understands what annuities are, their structure, return expectation etc. before taking a decision. Annuity plans can be of two types, Immediate annuity plans and Deferred annuity plans. Unlike an immediate annuity where the pension starts immediately, Deferred annuity has two main phases- a Savings phase where the premium one pays gets invested and the Income phase in which the corpus that is accumulated over time can be used to buy out an immediate annuity plan. Most of the pension plans are deferred annuity plans, where one pays a certain premium to build a retirement corpus, for future pay-out.

Since annuity plans are extremely long-term products, they are conservative in terms of their return expectations. During the accumulation phase, the money is parked majorly in fixed income instruments like Bonds. Usually, companies do not entirely pass the returns earned but retain a certain portion of earnings as reserves to meet up with any contingencies. Annuity plans deliver low rate of returns (between 7%-7.5%), which is pretty much in line with our country's inflation and may not be enough to provide for your retirement income. Moreover, only 1/3rd of the maturity value that can be withdrawn is tax free, the remaining 2/3rd must be utilized to buy an immediate annuity plan, to provide a periodic annuity which will be taxable. Also, usually, annuity plans do not factor in inflation, prices will keep rising and hence, the impact of inflation needs to be factored in or else our capital will erode.

The writer is CFA, founder, Happyness Factory