(Annuities are good for those who think they will outlive most others – So, in case you do take a plunge, take five minutes off to read this– Then take your time to plan your annuity products- There are some situations in which you can win with an Annuity- Like Life insurance is a must if you think you will die too soon, Annuity is for you if you think you will live too long).
This appears in today’s Deccan Chronicle.
BUYING ANNUITIES? SOME HINTS
In my last column, I had talked about the use of Systemic Withdrawal Plan and how using that gives an edge over the annuity product. I had promised to touch on how to use the annuity product and under what circumstances one should use them.
During our working period, we will keep saving and investing in different forms and hopefully have a corpus when we stop working for a living. Let us assume this event to happen when we are sixty.
We have a choice to use a corpus, put it in a Balanced Fund and keep using SWP for a period of, say 20 years. Our corpus will also be growing, even if I keep it in a liquid fund. And let us assume that the corpus will earn interest @5% p.a. In such a case, I can keep withdrawing Rs.16500 (approx) for twenty years and my corpus would be exhausted. If I can get 8% on my corpus, I can withdraw Rs.19295 every month and at 10%, I can get 22,717 every month. I looked at an annuity table of an insurance company and the promised annuity FOR LIFE is Rs.18300 every month. The payments will go on till I live.
In essence, an annuity will score if we are going to live for very long. Say beyond twenty five years from the time we buy the annuity. And the monthly payout keeps getting higher as we grow older. For example, an LIC Annuity table for one of their product guarantees a monthly payout of nearly Rs15000 for every lakh of rupees, if we buy the product when we are 80 years old. In essence, you get 18% of your investment amount every year, with NO RETURN OF PRINCIPAL. It may not be a bad product to buy when you are 80. The same annuity is just around 8.8 percent every year, with NO RETURN OF PRINCIPAL, if bought at age 60. In other words, the insurance company has taken the probability of your longevity whilst pricing the product.
Personally, I may put some money in to annuity, but gradually. Say, start at age sixty and keep on increasing the contribution every year. Till the money is shifted there, it is hopefully earning a return of anything from ten to twelve percent per annum in a Balanced Fund..
To give a simple illustration, if I have a corpus of Rs.100 lakh when I am sixty, I will keep half in a Balanced Fund and keep withdrawing around Rs.38,000 every month. My assumption is that this will last me around twenty five years. Should I die earlier, the balance will go to my nominee or legal heir. The balance fifty lakh will continue to be in a Balanced Fund, and at the end of 25 years, it should have grown to around Rs.135 lakh at a conservative seven percent per annum. At the end of 25 years, I can now buy annuities that give me a higher return, if I think I will last another twenty or so years. If I think I will last less than that, I will simply switch the entire corpus to an annuity that will give me around 18% of the corpus every year for the rest of my life.
The purpose behind the whole exercise is:
- give in partly to the fear of living very long;
- Not give up entirely on better returns on the money we have.
If I were to use my entire corpus to buy an annuity when I am sixty, I am doomed to a poor return. Of course, if the corpus is large enough and we do not want to worry, then by all means go ahead and buy an annuity for a few crores. It is a tradeoff between the heart and the mind.
In any annuity, the money you give to an annuity provider, is the principal amount, which the annuity provider will invest either in debt or a combination of debt and equity. They also would be offering prayers for your early demise, since the shorter the payout period, the higher their profit. Imagine I buy a life annuity and live just a couple of years. The corpus has been wasted.
There are annuities that offer to return the ‘corpus’ on your death, to the nominee of your choice. It could be for return of half the corpus or the full corpus depending on the product structure. However, in these cases, the monthly or annual annuity payouts are poor and in the zone of the savings bank interest rates. If we keep the same corpus in a bank FD, the monthly interest payouts would be higher than the annuity amount mentioned here.
Thus, an annuity can be used judiciously if you plan it well.