Personal Finance

Which is the right annuity option for you?

Kumar Shankar Roy |BL Research Bureau | Updated on: Feb 19, 2022

Money jars filled with American currency. Savings and donations concept. istock photo for BL | Photo Credit: CatLane

Since an option, once chosen, can’t be altered, understand the variants properly before buying

For investors who want guaranteed lifelong income, immediate annuity plans are an interesting alternative. Under an immediate annuity plan, you pay a lump sum and get regular payments as long as you desire. Life insurers offer variations of this product, but deciding on the right option can be tricky. Since annuity option once chosen cannot be altered as per norms, it is very important to understand them.

Life annuity, guaranteed period

Under this option, the annuity will be payable at uniform rate for the life of the annuitant. On the death of the annuitant, payments will cease, no further amount will be payable and policy will terminate. Your annuity will be payable regularly at the end of chosen annuity payment frequency from the date of purchase of the plan. This implies that for yearly frequency, the annuity payout will be after one year from the purchase.

For instance, a 50-year person buying LIC’s Jeevan Akshay-VII with ₹10 lakh purchase price (excluding GST) will get ₹71,550 (7.15 per cent) income annually for life. For a 60-year old, the income rises to ₹83,250 (8.32 per cent). The life annuity/income option gives you the maximum bang for your retirement buck compared to other options. However, this option leaves nothing for your nominee/dependents. All top life insurers, including HDFC Life, ICICI Pru Life, SBI Life and Bajaj Allianz Life offer life annuity income.

There is a variant where life annuity comes with a guaranteed period. Under this option, the annuity payments are made for as long as the annuitant is alive. But here comes the twist: on death of the annuitant during the guaranteed period of 5/10/15/20 years, the annuity will be payable to the nominee(s) till the end of the guaranteed period. But if death of the annuitant unfortunately happens after the guaranteed period, nothing will be payable and the annuity will stop. Using Jeevan Akshay-VII example, a 50-year old will get ₹71,350 to ₹69,250 annually as the guaranteed period rises from 5 years to 20 years. Under this, the plan will continue paying your income to nominee for a time after you die during the specified period. However, the risk is that if you die after the guarantee period, or with only a short time left, your beneficiaries won't get much or any continuing income.

Return of purchase price

Many people detest the idea of the insurer taking the purchase price paid for annuity when the annuitant expires under the lifetime income option. As it is, your initial capital comes via annuities in 10-12 years for those in 50-60 years age. So, insurers have come out with annuity options with return of purchase price or ROP.

The basic variant is immediate annuity for life with ROP; here annuity payment continues as long as the annuitant is alive but on their death, the purchase price is payable to nominee(s) and no more annuities are paid. This option allows you to leave something for your nominee. But do note that the annuity payments will be lower. For instance, ICICI Pru Guaranteed Pension Plan pays ₹67,741 yearly for 50-year male (single life) without return of purchase price but the annuity falls to ₹60,235 for ROP to nominee. Note the value of purchase price, say ₹10 lakh, would be eroded by inflation and may not mean much to your nominee if ROP is done after 10-20 years.

There are sub-variants such as life annuity with return of balance purchase price. Here, annuities are paid for the life of the annuitant, but on the death of the annuitant, the annuity payments will stop while the insurer pays to the nominee the balance of the purchase price i.e. purchase price minus all annuity instalments made prior to death. In this way, you get to milk the annuity and your nominee also gets what's left. Note that if annuity payments exceed the purchase price, no benefit will be paid on death.

Some plans provide ROP on diagnosis of critical illness (CI) and permanent disability (PD) due to accident. So, you get annuity for life till first occurrence of any of the specified critical illnesses or permanent disability due to accident, before a specified age. The purchase price is returned to you/nominee, in case of first occurrence of any of the specified CI or PD before the specified age. The ROP corpus here may act as a buffer to treat that CI or act as a cushion helping you tide over the post-accident life. Read the list and nature of CI covered by the preferred insurer.

Increasing annuity

Apart from fixed annuity, some insurers offer you the alternative in form of increasing annuity. Here, the annuity rises by 3-5 per cent every year. Jeevan Akshay-VII offers annuity for life increasing at a simple rate of 3 per cent p.a. HDFC Life offers increasing annuity at 5 per cent p.a. SBI Life Annuity Plus offers lifetime income with annual increase of 3 or 5 per cent.

Investing ₹10 lakh (excluding taxes) in the 3 per cent increasing annuity from SBI Life for instance, will start a 60-year old at annual income of about ₹63,842, which will rise by 3 per cent of the annuity amount at inception every year. The 5 per cent rise option will give a starting annual income of ₹56,390. These payments are easily 20 per cent less than the ₹79,864 yearly annuity under the lifetime income option (with no escalation and ROP). While increasing annuity plans are intended to protect you from inflation, they do an inadequate job because there is a trade-off involved. The hike is calculated at simple rates, so a modest increase of 3 per cent in annuity may be too small to shield against real inflation.

Factor in the absence of death benefit in increasing annuity plans especially if you wish to utilise this route to transfer wealth to your next generation.

Guaranteed returns in any investment product hardly ever come with high returns, and annuity plans are a good example of this. Also, the income you receive as annuity is fully taxable at your income tax slab rate too.

Published on February 19, 2022
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