Home-Made Annuity

Kripananda Chidambaram, 12 Jun 2013

A question we have often been asked by investors is - 'How to plan for regular income post retirement?' After all, government pensions don't cover most of us; and they are winding down for new government employees themselves. Building a decent corpus while you are earning is of course one part of the story. The other is to deploy this into something that gives an 'annuity', and that's what we will focus on in this article.

What is annuity?

Let's distinguish here between an annuity and an 'annuity product'. An annuity simply means a regular stream of income from your assets. The features you are looking for are a decent yield (beating inflation), safety of your corpus and regularity of income. If you have a piece of land or a large number of shares, you may have a good net-worth; but these cannot give you the regular income you are looking for. Also remember, you are planning not just for immediate running expenses, but for about 25 years of your retired life.

Annuity for retirement planning

It's easy to see how not to design your annuity. And that is to rely completely on a readymade annuity product (separately or as part of a pension plan). This is a product wherein you pay a lump-sum amount upfront, and in turn receive a regular payment as long as you and your spouse live. While these products are offered exclusively by life insurance companies, it is important to realize that there is no life insurance component in them.

There are some good reasons we say such annuity products are not good or sufficient:

  • Annuity yields in India are very poor. Most products yield between 5 percent and 7.5 percent, and there is no indication this is likely to go up anytime soon. This is even lower than the interest on a bank deposit today. These yields are going to leave you poorer over the years, as inflation erodes money's purchasing power. Further, remember that in a bank deposit, your principal is returned at the end of period, but not so in an annuity product.
  • Most readymade products bundle the investment phase with the annuity phase (such as in a pension plan). You will find it almost impossible to get a pure annuity anywhere, without participating for a few years in the investment phase first. This investment phase tends to have high charges and often ends up eroding wealth.

Let's look at better ways of going about this where you create your own annuity. If you are someone who doesn't understand or want to get involved in investments, you would rather have an 'invest it, shut it, forget it' kind of product (borrowing the phrase from a popular two-wheeler ad). There are two options:

1. If you are going to be in the lower tax bracket, the good old Post Office Monthly Income Scheme and a Scheduled Bank Fixed Deposit should take care of bulk of your requirements. These offer higher interest rates for senior citizens, and you can fill Form 15H to prevent TDS from being deducted. In addition, you can keep about 20 percent invested in equities (preferably in an index fund) to take care of inflation.

2. If you are in the higher tax bracket, a mutual fund Monthly Income Plan (MIP) works best. It is almost same as the above in terms of returns, but more tax efficient for your income level. A couple of good MIPs automatically take care of your asset allocation, and the monthly dividend option can give you the regular payments you need.

Both these are simple products, with low risk and low maintenance requirements.

If you are someone more interested in finance (after all, you may have much more time on your hands post retirement!), you can do more. Even here the two suggestions above can form bulk of your portfolio. Others include:

  • A residential or commercial property that gives you rental income. This calls for you to do the due diligence before buying the property, and also handling paperwork so that the tenant does not give you sleepless nights later. While the rental yield itself is usually only 4-6 percent, rental income is a good protection against inflation.
  • A PSU bond held to maturity. This combines safety with a good yield over several years. India Infrastructure Finance Company Limited (IIFCL) is one such bond that is incidentally tax free. Indian Railways, Power Finance Corporation and IDFC also come up with bonds from time to time. Here again, the key is to do your homework and buy these bonds at the right time, locking in a good yield. An ideal time is when interest rates in the markets appear to have peaked, and are on their way down.

In summary, financial comfort during your retired life is fairly simple to achieve. Assuming you have built a corpus over your earning years, you can assess your own tax situation and involvement in finance, and choose your product appropriately.

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