Death is not the biggest risk we face. It is the financial risk. A sum of Rs 1 crore may seem big today, but will it be enough for you and family for next 50 years? NO. This is one key reason why many people look for a guaranteed regular second income source. With the general interest rates of fixed deposits going down, keeping money in the bank may be a safe option but there is no guarantee that the interest income will remain fixed. In this article, we will discuss a sure-shot way that can help you generate a fixed and regular second income flow. The focus is on annuities.
Fixed income for as long as you want
Twenty years ago interest rates in most banks hovered around the 10-12% mark. Today, the same banks offer maximum 6-7% interest rate. Salary hikes for employees is few and far between. The only serious amount of hikes used to come from job changes, but that has weakened considerably given the overall economic and employment scenario in the country. The job market is full of experienced employees. But there are few takers. As a result, your single source of income is under threat.
This is why every individual/family is thinking about a second source of income which is more guaranteed and regular. In case the first source of income drops or ends, only a second source of income can help. One of the few ways to generate a guaranteed and regular income is through purchase of annuity product. An annuity involves one-time investment and then the pay-out can either begin immediately or after a decided time-period. The annuity plan where the income starts instantly is called 'immediate annuity'. On the other hand, the annuity plan where the income starts after sometime is called 'deferred annuity'.
For instance, if a 50-year-old buys a Rs 20 lakh annuity plan, he or she can immediately start getting a fixed annual income of Rs 1.35 lakh. This payment can continue for as long as the annuity buyer wants. So, if the buyer survives 50 years, they can get Rs 1.35 lakh X 50 (years) = Rs 67.50 lakh. This is more than three-fold of the initial Rs 20 lakhs invested. Please note two important things. One, the Rs 1.35 lakh immediate annual income is fixed and never changes. Two, the Rs 1.35 lakh income, as an example, is guaranteed for as long as the customer wants.
The guaranteed regular income can be even bigger if there is a deferment period. So, the same 50-year old person buys the Rs 20 lakh annuities and accepts a deferment period of 10 years. In this case, the guaranteed and regular income will start coming after 10 years i.e. when the person is 60 years. In this case, the annual income/pension will be Rs 2.16 lakh for as long as the customer wants. If the customer survives till 100 years, they can get Rs 2.16 lakh X 40 years = Rs 86.4 lakh. This is over four-fold of the initial investment.
Different annuity options
Annuity on single life. The annuity (income) is payable in arrears as per payment mode chosen by customer, for as long as the annuitant is alive. On death of the annuitant, the annuity payments will cease and no further benefits will be payable.
Annuity on joint life: The annuity (income) is payable in arrears as per payment mode chosen by customer, for as long as either of the primary or secondary annuitant is alive. On death of the both annuitants, the annuity payments will cease and no further benefits will be payable.
Annuity with return of purchase price: The annuity is payable in arrears as per payment mode chosen by the customer, for as long as the annuitant is alive. On death of the annuitant, the death benefit is payable as lump sum to the nominee and no further amount will be payable. Upon payment of the death benefit, the policy is terminated and all other benefits cease. The annuity can be paid immediately in case of 'immediate annuity' or can be paid after some time as per 'deferred annuity' terms and conditions.
There are various annuity options which are essentially a combination of the above. One of the most interesting annuity income options is where the annuity income increases every year. Yes, it is true. In this option, the lifetime income has an in-built annual increase of 3% or 5%. Thus, an increasing annuity is payable throughout the life of the annuitant which is increased by a simple rate of 5.00% p.a. for each completed year.
In this type of annuity where increasing option is available, all future annuity payouts cease immediately on death and the annuity contract terminates.
Disadvantages of annuities
Every financial product has some advantages and disadvantages. Annuities are not an exception. While annuities offer inbuilt flexibility, providing you an opportunity to always maintain your standard of living and complete freedom to indulge in life’s necessities without any compromises, there is a flip-side too.
One, annuity income is taxable. There is no tax-free benefit when it comes to getting annuity income. Since the annuity income is like interest income, there is income tax payable if you receive it. So, post-tax income will be lowered.
Two, annuity rates are lower for younger customers. While some annuity plans have minimum age of as low as 30 years, the effective annuity income is also low. This is because younger customers have the potential to live longer. For instance, a 30-year-old person buying Rs 20 lakh annuities can get annuity income between Rs 69,000 to Rs 1.21 lakh. But a 50-year-old person can get annuity income between Rs 80,000 to Rs 1.31 lakh.
Three, the cost of guaranteed regular income via annuities is not low. Since the life insurance company gives you a guarantee of regular income as long as you want it, the rate of return on your one-time investment can be 5-7% per year interest effectively. You may get higher interest income from other alternative avenues, but the guarantee of fixed payment/income may not be available there. (The writer is a journalist with 14 years of experience)