There was a time when salaried individuals with pension benefits could look forward to their retirement. The pension that they received was, in most cases, linked to their last drawn salary, which meant that most of them did not have to worry about pension being lower than their expenses. They were financially comfortable with what they got as a defined pension.
However, over the past couple of decades, the cost of living has gone up, disturbing the best-planned pension plans. There has also been a policy shift with defined benefit pension giving way to defined contributions. The shift has taken away the entire pension safety net, as now on how much pension you receive is a factor of how much you save towards a retirement corpus.
NPS: Focused on retirement savings
There are very few financial products that are strictly focused on retirement savings. For instance, the EPF and PPF are oriented towards retirement savings; there is no compulsion to stay invested in them till you actually reach retirement. You can access these savings options earlier than you retire, unlike the NPS (national pension system), which compels you to stay locked-in till you retire.
The NPS is a voluntary retirement scheme through which you can create a retirement corpus or your old-age pension. It’s managed by PFRDA (Pension Fund Regulatory and Development Authority) and available to all Indian citizens (resident or non-resident) between 18 and 65 years old.
Read: NPS: Everything you need to know
On maturity, which is when you turn 60, 60% of your corpus is transferred to your bank account, while the remaining 40% you have to buy an annuity product necessarily. So what is an annuity, and why you need to buy it? Let us tell you all about it.
What is an annuity?
An annuity is a type of financial investment that pays out a fixed and regular dividend. These are long-term contract from an insurance company where you invest your money in return for an income in the form of regular payments. You could also understand their structures if you reverse the way life insurance products are structured. Just the way you pay regular premiums in a life insurance policy, in case of annuities, you receive regular payments. Likewise, if life insurance protects you against the risk of early death, annuities protect you against the risk of living for long.
One could also view annuities as a flexible retirement plan to create an income stream or to supplement an existing income. There are basically two types of annuities – deferred and immediate. With an immediate annuity, you can create an instant income stream, but with a deferred annuity, you can time the annuity for a later date.
Types of annuities
There are many types of annuities based on the features one is looking for (See: Annuity types), and there is merit in checking them out as each type is suitable for specific annuitants. For instance, one may want to receive annuity payments through their life term, even as some others may wish to receive a fixed payment for a limited period of time. The choice available caters to different individual needs, and annuitants can zero down on the one that meets their requirements.
| Annuity Types | Variants |
|---|---|
| Frequency of Premium | SingleRegular |
| Type of Payouts | FixedVariable |
| Time Payouts Start | ImmediateDeferred |
| Duration of Payouts | Life AnnuityTerm Certain |
| No. of People Benefitting | Single LifeJoint/Survivor |
| Nature of Purchaser | IndividualGroup |
There is a further choice within the payouts (See: Common annuity options) with which annuitants can plan their retirement income, keeping several factors in mind. For instance, an inflation-linked annuity can help cushion the impact of rising costs, whereas an annuity for life and survivor can help you maintain the income stream for your spouse after your demise. The structure of annuity is definitely oriented towards ensuring a regular income flow for someone retired or someone looking for an income stream even at a younger age. For instance, in the case of individuals who may have received a windfall and do not have the wherewithal to manage it, they may find creating an income stream from the windfall.
Common Annuity Options
| Life Annuity | Pays uniform rate of pension till subscriber survive |
| Life and Certain | Pays 5, 10, 15 or 20 years of certain pension & then till the time subscriber survive. |
| Life and Repurchase | Pays for life and then return the purchase price to nominee |
| Inflation-Linked | Pays for life with increase in pension amount @ 3% p.a. |
| Life and Survivor | Spouse is also covered. Pension paid till the life of subscriber, and post-death also paid to the spouse. |
Annuity Options Under NPS
When it comes to the NPS directed annuity scheme, the current choice is limited to 7 approved annuity providers (ASPs) (See: PFRDA approved annuity service providers for NPS). You will have to choose one annuity provider at the time of NPS account maturity. The annuity amount you get will depend on the prevailing annuity rates.
While checking the immediate annuity rates, do not confuse it with bank FD rates, because a 6.5% immediate annuity for a 60-year-old for 10 years is not the same as 6.5% FD return. The FD return is one time, whereas the annuity payout is for a 10 year period. So, do look deeper when you are checking the annuity rates.
| PFRDA approved annuity service providers for NPS |
| 1. Life Insurance Corporation of India (LIC) |
| 2. HDFC Life Insurance |
| 3. ICICI Prudential Life Insurance |
| 4. SBI Life Insurance |
| 5. Star Union Dai-ichi Life Insurance |
| 6. Kotak Mahindra Life Insurance |
| 7. IndiaFirst Life Insurance |
Annuity and taxation
All things good come with a downside and so do annuities. Annuity rates are not very transparent or easy to follow. Just the way insurance premiums vary across insurers for the same amount of cover and tenure; so does annuity. The annuity rates across insurers vary, and it may be a good idea to shop for offers before zeroing down.
Likewise, the tax treatment on annuities also needs to be factored. There is no tax incentive with annuities, as the annuity that one received is treated as income and taxed according to the slab rate that one falls in. However, as there is little choice for NPS subscribers at the time of maturity, they have to opt for an annuity with 40% of the corpus at the time of redemption.
In the absence of suitable alternatives, an annuity does work for people looking for a fixed and regular income in retirement. The predictable cash flow serves the purpose for many, and they can use their other savings and investments to counter rising expenses and other factors impacting their cost of living. Your objective when taking an annuity should be to achieve income protection over the long term rather than the growth of the principal. If a fixed income is your priority in retirement, an annuity could be the product to depend on.
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