Ashish and Bala are both 50 year old Vice Presidents in a renowned IT firm. Both are looking to retire in about 10 years’ time and want guaranteed income for their lifetime once they retire. Incidentally, both have received handsome bonuses recently, which they want to invest in an instrument that will help to ensure a guaranteed income post their retirement (at age 60).
They started browsing the internet for instruments which provide guaranteed lifetime income, consulted a few financial advisors and came across immediate annuity products offered by life insurance companies. These plans provide a guaranteed lifetime income (or annuities) at a rate which is decided at the time of purchase. Income can be taken monthly (or yearly) starting 1month (1 year) from the date of purchase. They found the annuity rates offered by popular insurance companies at age 60 are currently in the range of 6.5%-6.8%.
But, they had a problem …. Retirement was still 10 years away, so immediate annuity plans weren’t of much use to them, as of today. No annuity plan available in the market offered them guaranteed income starting 10 years from now,
Then they came across the deferred annuity option offered by HDFC Life Pension Guaranteed Plan. Ashish was attracted to the high annuity rates (῀12.5%) that it claimed to offer, if he invested today. This plan would help him to start his income 10 years later.
Bala pointed out that the 12.5% rates is on the initial Purchase Price and that would anyway earn some interest in the first 10 years, when no annuity is paid. Bala pointed at 1 0-year fixed deposit rates, about 6.5% p.a. available with some banks. His view was simple – Step 1: Invest now in 1 0-year Fixed deposits. Step 2: Use the corpus built 10 years later to purchase an immediate annuity at that time, to get lifetime income.
This is what would happen. At 6.5% p.a. for 10 years, Rs. 1 Cr. will grow to become Rs. 1.88 Cr through a simple fixed deposit. This could then be invested in an immediate annuity plan (at that time) to generate a higher annuity amount than what HDFC Life Pension Guaranteed Plan is promising.
Ashish did some homework and found the following …
- Immediate annuity rates are dependent on prevailing interest rates
- The immediate annuity rates available when he turns 60 (1 0 years hence), could be very different from the current rates.
- He looked at the government bond yields in India over the last 20 odd years and the graph looked quite volatile (but trending downwards over the long term).
SOURCE: TRADING ECONOMICS | MINISTRY OF FINANCE, GOVERNMENT OF INDIA
Ashish realized that interest rates (and hence immediate annuity rates) in 2028 (when he retires) could be very different from what they are now. He chose to invest in HDFC Life Pension Guaranteed Plan to get rid of the risk of future interest rate fluctuations. After all, when it comes to retirement, guarantee is the highest priority.
So now, let us see what would the future look like for both Ashish and Bala, given their choice of instruments.
|Lifetime annual income1 (annuity) from age 60…|
|Assuming the Immediate Annuity Rate 10 years from today||The Ashish way||The Bala way|
|Invest Rs. 1 Cr. In HDFC Life Pension Guaranteed Plan at age 50, to receive the below income very year, after 10 years, in Rs.||Step 1: Invest Rs. 1 Cr. in 10 year fixed deposit (at 6.5% interest)
Step 2: Use the proceeds of the fixed deposit 10 years from now (about Rs. 1.88 Cr.) to purchase an immediate annuity at the then prevailing rates and receive the below income every year, in Rs.
|7%||12.5 lac||13.1 lac|
|6%||12.5 lac||11.3 lac|
|5%||12.5 lac||9.4 lac|
|4%||12.5 lac||7.5 lac|
It is quite simple:
If you are an individual planning to retire 5-10 years later but want to lock-in an annuity rate
today, HDFC Life Pension Guaranteed Plan is perhaps what you can use
If the guarantee is not what you are seeking and you believe higher annuity rates in the future
are a possibility, you can try going the Bala way or choose its variants.
1. The above analysis excludes the impact of tax. Both fixed deposit interests and annuity proceeds are taxable as
per current tax laws.