Publication: DNA, Mumbai; Date: December 30, 2006; Section: Personal Finance; Page: 6.
Combining life insurance and pension planning is not right
Like childrens insurance plans, retirement plans also suffer from what I call the “label” effect. Right from emotionally appealing advertisements like “Sar Uthake Jiyo” to aggressive marketing tactics, the insurance industry leaves no stone unturned to cause confusion in the minds of buyers of insurance products. So, what exactly are retirement plans, or pension plans as they are popularly known as.
First for some definitions
a. Webster defines pension as a fixed-sum paid regularly especially to a person retired from service.
b. Annuity : A sum of money payable yearly or at other regular intervals
c. Immediate annuity: A pension plan that starts an immediate payment of a sum of money at yearly or other regular intervals. (Immediate annuities are actual pension plans that keep the sanctity of the word pension intact)
d. Deferred annuity: Unlike an immediate annuity where the pension starts immediately, deferred annuity has two main phases — the savings phase in which your premium is invested, and the income phase in which the corpus you have accumulated in the savings phase can be utilised to buy an immediate annuity. (In a nutshell, they are accumulation instruments carrying the misleading tag “pension”)
Most pension plans in India are deferred annuities, where the premium you pay is invested to build a retirement corpus for you. Now does that mean that retirement plans are the best way for you to build your retirement corpus? Certainly not!
These deferred annuity plans can either be endowment types like the ones from Life Insurance Corporation (LIC) or unit-linked plans, which private insurance companies are gung ho on these days. Some of these plans also come clubbed with life insurance.
Life insurance and pension serve two different purposes. While traditional life insurance policies protect against “dying early”, an annuity, in essence, can be used as an insurance against “living too long.” In brief, if you buy an annuity (generally from an insurance company), you will receive in return a series of periodic payments that are guaranteed for a particular period. So, the very fact of combining these two is ridiculous and should be avoided by all means.
Immediate annuities can play a role in the portfolio of a retired person who has accumulated a corpus and now expects a fixed-income from that. Here again one should utilise options such as Senior Citizens Savings Scheme and Post Office Monthly Incomes Schemes first as the yields tend to be higher than the immediate annuities currently available in the market. At the same time, one should give deferred annuities a complete miss. So why should you avoid deferred annuities that are sold as pension plans.
Costs: Most deferred annuities have a first year charge in the range of 18-27 %, which is exorbitant for any investment product.
Taxes & lack of flexibility: Only 25-33% of the corpus you build through the savings phase is tax free on maturity and you would compulsorily have to purchase an immediate annuity (which is taxed as income in your hands) with the remaining corpus at the prevailing rates at that point of time.
I fail to understand why someone would invest in an equity-oriented unit liked pension plan and get only 25% of his corpus tax-free when currently you have options to get 100% tax-free corpus through several options (such as PPF, EPF, voluntary contributions to provident fund, equity oriented mutual funds and direct stocks) that you can utilise for any purpose.
You will still have a choice of buying an immediate annuity that will start paying you a pension the very next month after you buy it.
Surrender charges: Surrender charges can be very high and you will get around 50% of the premiums paid from the second year onwards provided you have paid the premiums for at least 3 years.
So what is the whole point of locking yourself to an inflexible product like a deferred annuity when you will have a choice at the time of retirement to buy an immediate annuity anyway?
Now let us do a status check on all the pension plans available in the insurance industry. Almost all so-called pension plans available in the market right now are deferred annuities and there are hardly any immediate annuity options available. Guess what, till some months back, LIC was the only company offering immediate annuities because it was the only insurance company till 2001.
So which are the immediate annuities available in the market today?
Jeevan A www.licindia.com/jeevan_akshay_plan_009_features.htm: LIC
Immediate Annuity: ICICI Prudential
Bajaj Allianz Swarna Raksha ROC
If you are a retired person you can look at one of the above offerings which will broadly give you the following options.
Regular annuity for life
Annuity payable for 5, 10, 15 or 20 years certain and thereafter as long as the annuitant is alive.
Annuity for life with return of purchase price on death of the annuitant.
Annuity increasing at simple rate of 3% p.a.
Annuity for life with a provision of 50 or 100% of the annuity to spouse for life on death of the annuitant.
Nevertheless, immediate annuities fail to guard against inflation and might give a nominal income increase of 3% in one option. If, however, you are just trying to build your retirement corpus, you would do well by referring to the Webster for the meaning of “pension” and then choosing an appropriate product rather than just falling for the hard selling that insurance companies indulge in.
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