The National Pension System (NPS) is one of the preferred retirement options, thanks to its low cost structure and tax advantage. But one thing that concerns investors is the mandatory requirement to lock into an annuity product on exit. The requirement to purchase an annuity is for providing a monthly pension after retirement. If you are planning to enter the NPS or are an existing subscriber reaching your retirement age, here are some of the important factors to know about the annuity product.
Under all citizens model, for subscribers on turning 60, it is mandatory to buy an annuity plan with at least 40 percent of the NPS corpus (unless subscriber decides to defer the exit). The balance 60 per cent is paid as lump sum to the subscriber. If the subscriber chooses to prematurely exit from the NPS before the retirement age, at least 80 per cent of the accumulated corpus has to be utilised for the purchase of annuity.
The four main variants of annuities include — Annuity for life (annuity for life time and on death of the subscriber, annuity ceases); Annuity for life with return of purchase price (on death, annuity ceases & 100 per cent of the purchase price is returned to the nominee); Joint life, last survivor without return of purchase price (annuity for life time and on death of the subscriber, annuity will be payable to the spouse for life time. On death of the spouse, annuity ceases); and Joint life, last survivor with return of purchase price (same as earlier, but purchase price will be returned to the nominees on death of the spouse). There’s one more option – ‘NPS – Family Income’, a dedicated annuity option offered only to government employees.
Currently, there are 13 life insurance companies empanelled with the Pension Fund Regulatory & Development Authority (PFRDA), from whom you can select the annuity product. One can use the link – https://cra-nsdl.com/CRAOnline/aspQuote.html – to compare the annuity rates for different annuity variants provided by the all service providers.
Return on investment
When you purchase an annuity, you get a fixed income at the annuity rate throughout life irrespective of interest rate movements. Since the annuity pays you for life-time, it also reduces the risk of re-investment of capital. These benefits come at a cost, though, which get accounted for in the annuity rate.
Currently, the annuity rates for products with the return of purchase price (ROP) are in the range of 5.5-6.6 per cent for an individual of 60 years for an annuity purchase of ₹40 lakh. Though not a perfect comparison, we can look at the return on the ROP annuity products versus that on non-cumulative bank deposits and the Pradhan Mantri Vaya Vandana Yojana (PMVVY). Today, banks are offering 6-6.5 per cent on their ten-year FDs. The PMVVY – with a limit of ₹15 lakh for a single account and a lock-in of ten years – is offering an assured pension of 7.40 per cent per annum payable monthly for all the policies purchased till 31st March, 2022.
There are no investment products that can be compared with the annuity products with no ROP, which pays higher annuity than those with the ROP option. The internal rate of return (IRR), which is an effective way of calculating the return on investment in this case, increases as the subscriber goes on to live longer. For instance, a 60-year old purchases an annuity with annual fixed income of ₹80,000 for ₹10 lakh today. If she lives to 80, her IRR would be just five per cent. But if she lives till 100, then her return jumps to 7.6 per cent.
Annuity products with no ROP can be opted by those with no dependents or liabilities. Note that the income you receive from your annuity plan is taxable at your income tax slab rate.
To overcome the low rates on annuities, PFRDA appears to be working on an option in which the corpus would continue to be managed by pension fund managers but subscriber gets to have periodic payouts, similar to systematic withdrawal plans of mutual funds.
Deferment of annuity
While annuity providers reset the annuity rates periodically, the rate prevalent at the time when you purchase the annuity is applicable to all future annuity pay-outs. Since we are in the low interest rate environment, rates are expected to inch up. Thus, if you are an existing NPS subscriber who is close to retirement and does not need a periodical annuity income, you can defer buying annuity. Also, the longer you defer the purchase of annuity, higher the pension you will get as the number of years over which the insurance company has to pay the annuity comes down. As per NPS rules, one can defer the annuity purchase by 3 years from the time the subscriber exercises the option to withdraw the non-annuity portion (60 per cent, or 80 per cent of the corpus in case of pre-mature withdrawal).
Less scope to alter annuities
Subscribers under all citizen and private sectors can choose from monthly, quarterly, half yearly or yearly payment frequencies (only monthly for government employees). Once an annuity is purchased, the option of cancellation or reinvestment with another annuity service provider or in another annuity scheme is not allowed after the free look period. Surrendering the policy, too, is restricted only to special circumstances such as a critical illness. This would be available only for the annuity option with ROP, however, at high charges.