Why do I need an annuity for retirement?
Retirement Planning is complicated. Many aspects are the subject of hot debate, even among the experts.
Let me break down the answer to your query.
- The first question is: How long will I live?
Sandra Tsing Loh
once said with a dose of humour, “In 1900, the average life expectancy of a U.S. citizen was 48, so most menopausal women were dead, which is not a great place to be.” Though spoken in jest, it pointed to an important blind spot and largest risk related to retiring: the longevity risk.
According to a World Economic Forum report, we better be prepared to blow out over 100 candles on our birthday cakes. Those born in 1947, have an average life expectancy of 85 years, it goes up to 103 for those born in 2007.
According to MacroTrends, the average life expectancy in India in 1950 was 35.21 years, it is now 69.96 years. But if you have not suffered from malnutrition and are in good health, the average is no indication.
This means that our investment corpus needs to be much fatter. Because with longevity risk comes shortfall risk: the possibility of outliving one’s savings. So don’t smirk if you are advised to develop a retirement plan based on the expectation of living to 100.
This is why advisors and researchers champion the idea of purchasing income annuities for retirement, arguing that doing so provides longevity risk protection. Please do read 4 ways longevity is going to change everything.
An annuity is a financial instrument issued that is backed by an insurance company. Its aim is to provide guaranteed periodic payments for the life of the contract, regardless of market conditions.
The National Pension Scheme, or NPS, is a voluntary retirement scheme through which you can create a retirement corpus or your old-age pension. It’s managed by the (Pension Fund Regulatory and Development Authority (PFRDA) and available to Indian citizens above the age of 18.
When you turn 60, 60% of your corpus is transferred to your bank account, while the remaining 40% you have to buy an annuity product.
Here is a list of List of Annuity Service Providers (ASPs) empanelled by the PFRDA.
As is evident, annuities do provide peace of mind as they provide a regular inflow of cash. Having said that, annuities will be less useful for retirees who are deriving a healthy share of their income needs from pension, rental off real estate property, dividends from stocks - basically one who has multiple cash flow streams.
Also depends how large your investment corpus is and what the withdrawal rate is. The safe withdrawal rate (SWR) is how much a retiree can draw annually from their accumulated assets without running out of money prior to death. It’s unknowable. You don’t know what the major asset classes will return or how high (or low) inflation will run during your retirement. Nor do you know how long you’ll live.
I know someone who resides in Goa and manages her house based on the income from renting a home in Mumbai. Her son gives her and her spouse a small sum to “just enjoy”. So basically, there is no one-size-fits-all solution. But an annuity does have strong pros.
More by Investment Specialist Larissa Fernand
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