Annuities are one of the popular investment options these days especially for people who are on the verge of retirement or who are already retired. With the product becoming more and more popular, I am pretty sure someone in your family may be considering signing up for one of these. The purpose of this article is to explain to you, what an Annuity Is and whether it is a good choice for Investment...
What is an Annuity?
An annuity is nothing but a lump-sum investment, which gives a regular income to the investor for the rest of his life.
Annuitiies can be of two types:
- Immediate Annuity - The Scheme starts paying out the regular income right from the first month
- Deferred Annuity - The Scheme starts paying out the regular income after you achieve a certain age or after completion of a certain vesting period
Who can Offer/Sell Annuity Schemes in India?
As of now, only Insurance Companies can offer Annuity Schemes in India. Almost all banks, financial institutions and financial advisors are approved to sell or distribute these products.
Is Annuity Something I sign-up Individually?
Actually No. Most Pension Plans that are being sold these days have some clause or the other which mandates that you sign-up for an Annuity Scheme using at least a certain set % of your corpus. For ex: The NPS Scheme mandates that you signup for an Annuity with atleast 40% of your final corpus. Most Pension Plans floated by Insurance Co.'s expect you to Invest at least 60-70% of your final corpus into an Annuity Scheme. Whats worse is that, you have to sign-up for an Annuity that is offered by the same Insurance Co only. You cannot take the money outside.
Is Annuity a Good Option?
Though Annuity might look like a good option, I personally feel that there are better options that are available in the market. You might be wondering - WHY. The Sad Truth is, the person who is selling you this annuity WILL NOT tell you the below points.
Reason No. 1: Low Rate of Returns
Most Annuities in India Offer Rate of Returns that is lesser than 8% per year. 8% is the Max and is offered only by a few Select schemes. Almost all the others fall in the 7-7.5% range. In fact there are Annuity Schemes that offer as low as 5% or 6% per year returns
Reason No. 2: Service Tax - Eats your Returns
Annuities are subject to Service Tax. The current prevailing service tax % is 3.09%. So, if you Invest Rs. 10 lakhs in an Annuity Scheme, Rs. 30,900/- goes out as Service Tax and only the rest gets Invested effectively. This effectively brings down your yield or profits by at least 0.25%.
For a 10 lakh Investment, @ 8% Returns the Interest you will earn in one year will be Rs 80,000/- whereas if you consider the Service Tax outflow, you will only earn Rs. 77,528/-. You are losing Rs. 2,472/- worth of Interest just because you have invested in Annuities...
Reason No. 3: Income Tax - Eats your Returns Even More
The Income you earn every month through these Annuity Schemes are FULLY TAXABLE. In fact, this amount is not even eligible for Standard Deduction. So, whatever Annuity Income you earn is FULLY AND TOTALLY TAXABLE.
Now Go Back and Re-Think, Are Annuities Good Options?
For New Investors:
If you are someone who is yet to signup for an Annuity Scheme or a Pension Scheme that Mandates you to Invest a certain % of your final corpus into an Annuity, Think multiple times before you decide. The effective rate of returns, after considering the taxes will be much lower than what you think it would be.
My Recommendation - Stay Away.
For Existing Investors of Annuity Schemes:
If you are already signed up for an Annuity Scheme, there is not much you can do. Try to manage your taxes properly so that you pay as-little income tax as possible on your eventual Annuity Income
For Existing Investors of Pension Schemes - That Mandate Annuity Subscription
If you are already signed up for a Pension Plan that Mandates you to Invest a certain % of your final corpus into an Annuity firstly, try to make partial withdrawals before the eventual maturity date (without paying any penalties/fees). Secondly, invest only the bare minimum % into the annuity and divert the rest into a better investment option.
What are the Alternates?
There are 2 possible Alternates that can offer much better returns than Annuities. They are:
a. Bank FD's (Select Monthly Interest Payout Option)
b. Monthly Income Plans