Annuity Plan, With Guaranteed Income? Here Is How You Can Compare Returns.
In my email today was an advertisement for an annuity plan. The marketing pitch for such plans is compelling. Here is my attempt to help you objectively evaluate an annuity plan, should you need to.
On the face of it, the plan I saw looked good. It also had the magic words – guaranteed income.
There are only two things guaranteed – death and taxes
It was like most annuity plans you would have seen. You pay an X amount of money annually for a number of years. Say 5.13 lacs for 10 years. From the 11th year, you will get a payout of Y annually, say something like 4 lacs. You will get this ‘guaranteed’ payout for as long as you are alive. To make the deal sweeter, there is an insurance cover, whenever you die, your nominee will get 51.3 lacs.
You might have seen the same or similar plans in your emails, the numbers might vary a bit, the construct is largely the same.
No, I am not going to straight out say that the plan is bunkum and you should ignore it. Not at all, in fact, it is a decent plan. Worth evaluating.
However, I do want to draw a couple of comparisons and lay down some principles for evaluating such plans.
What can you compare to an annuity with guaranteed returns?
Well, I would propose two alternatives for comparison: 1. A long term fixed deposit with a nationalised bank like the SBI. 2. A Gilt Fund, which invests in RBI bonds, guaranteed by the Govt of India, no less.
I honestly believe these are fair comparisons to make with any guaranteed plan. Of course, you can have your own threshold of what is an acceptable ‘guarantee’.
So, on the one hand, you have an annuity plan where you pay an amount to the agency for 10 years. On the other hand, you can put the same amount every year into an SBI Fixed Deposit or invest in a Gilt fund. The payout from the annuity fund will be replicated by you withdrawing from the FD or selling units of the fund.
- Let us look at the current rates with the SBI. For sr. citizens it is 6.2% and others 5.4%. So assuming the person is 50 when he starts the plan, we will take 5.4% for the first 10 years and switch to 6.2% from the time the person turns 60.
- For the Gilt fund, there are many options. We can choose the largest one (in terms of money invested in the fund). It turns out to be SBI again, the SBI Magnum Gilt Fund, Direct Plan, Growth. The SBI Magnum over 5 years has given a return of 9.89%. But let us be pessimistic and look at the lowest return of any Gilt Fund over 5 years. The lowest return is 7%, IDBI Gilt Plan. We will use 7% returns for the purpose of this illustration.
Let us use 3 points in time for the comparison, the investor – 1. passes away at age 70, 2. kicks the bucket at 80 or 3. cops it at 90. Below is a table with a straight comparison of the three options.
In the above illustration, the FD at 5.4% also looks like giving better returns than the annuity plan. The Gilt fund of course gives the best returns and with compounding the returns look much better over a longer period.
However, there is one more angle to cover. We need to account for taxes. Taxes will be deducted from the payout and you will receive the balance.
Annuity income is taxed like any other income. Assuming that you will be in a 20% tax bracket at 60+, the 4 lac payout will entail a 80K income tax, leaving you with 3.2 lacs in hand.
Fixed Deposit will have tax deducted at source. Therefore every year the interest earned will be taxed and the balance available to you to re-invest. To make the comparison realistic, we will assume a tax rate of 30% till age 60 and then 20%, same as the annuity plan.
For the Gilt fund, there is short term and long term capital gain. In this case, we will only have long term capital gains. The rate is 20% with indexation, which makes the applicable rate lower, but for simplicity, we will assume a flat 20%.
Phew, tax makes everything complicated. But then, the only real guarantee in life are taxes and death. On that pleasant note let us relook at the comparison taking taxes in to account.
With taxes coming into the picture things change a bit. But even here we see that in most cases an FD is still better than an annuity unless you are sure about hanging around till 90 or later. However, Gilt funds are still a no-brainer even with taxes.
Fun fact: In current actuarial tables the male life expectancy in India is 75 and female 80.
Keep in mind, we have taken the worst-performing Gilt fund for illustration. If it were the SBI magnum which gave returns of 9.89% then you would be looking at leaving behind: 1.2 Cr at 70, 2 Cr at 80 and 3 Cr at 90 after tax. Sweet compounding at work.
So, to summarize this, look at any new investment recommendation from your agent/bank and do your own calculations to decide whether it makes sense or not. The actual effort is about 30 mins including some amount of googling for information. You should be able to construct your own comparisons and make informed decisions.
Use comparable investments, I would recommend Gilt funds for debt/annuity type of proposals and Index funds for anything linked to equity. Take taxes into account for everything you compare and push your agent to do the hard work and show you the comparison. Armed with the numbers you can take an objective call.
However, there is one very important aspect here, all of this is on spreadsheets. In real life, investment is as much an emotional decision as a monetary one. If you do not have the discipline to invest regularly in a Gilt Fund then this conclusion is of no tangible benefit. If the only way you will invest is when your agent reminds you on 1st March every year to make a payment, then you have no choice really.
While the numbers show one thing, don’t let them get in the way of doing your best for long term investment. An investment that lets you sleep peacefully at night is the best one.
You can also read about mutual funds classifications and about the very basics.
