A pension plan that guarantees future returns now

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HDFC Standard Life Insurance Co. Ltd has launched an annuity product called HDFC Life Pension Guaranteed Plan. Annuities are pension products that offer a fixed sum every year. You can buy this product in two ways: deferred and immediate. A deferred annuity requires you to first build a corpus, and then use it to buy an annuity. For an immediate annuity, you don’t have to accumulate a corpus; just take your money and buy an annuity from any insurer. The plan by HDFC Life offers both options, and goes a step further.

The plan allows you to lock in your annuity rate at the time of buying the deferred annuity option. In a typical deferred annuity plan, you invest first and then use this money to buy an annuity at the then prevailing interest rate. In that sense, the plan by HDFC Life takes care of the interest rate risk. But is that enough?

Immediate annuity

The immediate annuity plan offers two options—annuity for life; and annuity for life with return of purchase price. The first option pays annuity for life. On death of the annuitant, the benefits stop. In the second option, the plan returns the purchase price to the nominee. You can take it on an individual basis or on a joint life basis (annuity will continue as long as one of the annuitants is alive, and return the purchase price on death of both annuitants under the second option).

Annuity rates are guaranteed for life. Typically, the older you are the higher is the annuity rate.

Deferred annuity

Under this option, you buy the annuity upfront and lock in to the current annuity rate; pay-outs happen later. This option comes with a return of purchase price variant with single and joint life options. The maximum deferment period is 10 years.

The annuity pay-out rate depends on factors such as age and deferment period: the older you are and higher the deferment period, the more is the annuity pay-out. On annuitant’s death, the return of purchase price option pays a minimum of 110% of the purchase price as death benefit.

“This policy offers better liquidity options than other annuity instruments. It offers a loan facility during the deferment period and also surrender at any point for the return of purchase price options. The surrender amount will be the present value of all future benefits discounted at the prevailing interest rate plus 2%,” said Srinivasan Parthasarathy, senior executive vice president, chief actuary and appointed actuary, HDFC Standard Life Insurance Co. Ltd.

How does it work?

Under the immediate annuity option for a sum of Rs50 lakh, a 60-year-old will get life annuity at a rate of 8.12% and the return of purchase price option will come at 6.57%. (You could instead consider the insurer’s new immediate annuity plan that offers a better rate.) For deferred annuity pay-out, advertised annuity rates are up to 13%. But this is not how you should look at this product.

The higher interest rate is due to the fact that you commit a big corpus in advance. You forgo an opportunity to get returns on this. So, the time value of money actually erodes the value of money. It’s on this eroded value that the annuity rates apply. Say, a 50-year-old buys deferred annuity with a deferment period of 10 years, with a purchase price of Rs50 lakh. The product offers a guaranteed pay-out of Rs6.27 lakh per annum or an annuity rate of about 12.54%. But this can be misleading as this is the rate at which the payouts happen. What you need to know is the rate of return, for which you need to factor in the time value of money. If you consider that, the actual return will be about 6.3%, assuming the person lives till 90 years of age.

What should you do?

Annuities make sense for those who want guaranteed pay-outs. But retirement is also about managing longevity risks and so one needs to ensure that investments beat inflation. We suggest you have only a portion on your money in annuities.

The deferred annuity variant of this plan takes away the interest rate risk, but at a cost. One needs to be mindful of the economic scenario when taking a call on the deferred annuity option, said Shyam Sunder, managing director, Peak Alpha Investment Services Pvt. Ltd. “We are likely to move into an upward interest rate cycle, so locking into a rate at the lowest point in the cycle may not be advisable. Further, if a person has 10 years to retirement, then I recommend a more aggressive approach by investing in equities so that a person is able to achieve higher returns instead of keeping the money in an annuity that yields low returns of 2.3-7.1%,” he added.