MFs Better Than Annuities For Retirement Planning

When it comes to retirement planning, investment in mutual funds is a better option than buying annuities as MFs fare better in terms of liquidity, returns and tax efficiency




Retirement planning is of utmost importance in a financial plan. In many developed economies, they do have some sort of arrangement where a fixed amount is deducted from an individual's income and is made available at the time of retirement as part of the social security scheme. However, in our country, though the government is taking steps in that direction with the introduction of NPS (National Pension System) and now also with the "PM Shram Yogi Mandhan" scheme, which makes pension available to person from the unorganised sector. Despite all these efforts, most of us are still ignorant about planning our retirement. People believe that they have sufficient savings and investment to fund their retirement. They even argue that they are already doing retirement planning by investing in PPF (Public Provident Fund) and they are also entitled to EPF (Employee Provident Fund). But the reality is that there are very few people in our country who have a dedicated retirement plan in place, forget about people reviewing their plans periodically .

Some of the serious individuals go for annuity plans offered by insurance companies. However, when it comes to planning for retirement, how do these plans compare with mutual funds and, if there is a choice, should you opt for annuity plans or mutual funds? We will find out shortly.

We all know what mutual funds are, thanks to the "Mutual Fund Sahi Hai" campaign by AMFI (Association of Mutual Funds in India). But people know very little about annuity plans. They only know what insurance agent tells them. So, let us understand what are annuity plans and the different annuity plans available in the market.

What are annuity plans?
An annuity plan from a life insurance company is a product that gives you fixed cash flow and primarily serves as a source of income for retired people. Annuity plans are developed by life insurance companies that are governed by IRDAI (Insurance Regulatory and Development Authority of India) regulations. The insurance companies accept funds from people and invest them. On retirement, individuals receive constant cash flows from insurance companies. The time period for which people invest in an annuity product, i.e. before regular cash flow begins, is termed as the 'accumulation phase'. Once cash flow commences, it is termed as 'annuitisation phase'.

What should you do?
If we look at the structure of annuities and mutual funds, they are poles apart. When it comes to annuities, you would be able to avail tax benefits under section 80C during accumulation phase just like ELSS (Equity Linked Saving Scheme) of mutual funds. The average 5-year performance of the pension plans stands at 10 per cent. This includes equity, debt and hybrid. If we look at the 5-year performance of mutual funds for the same period, the returns were 11 per cent. If we look at equity funds of annuities, they have given average 5-year returns of 9.71 per cent, whereas equity mutual funds have given 11.30 per cent average returns in the last 5 years.

Although there is no big difference in the returns of annuities and mutual funds, there are other factors that need to be considered before finalizing your retirement product. When it comes to withdrawals, there are limitations on the number of withdrawals one can do every year under the annuity scheme. There is no such restriction in the case of mutual funds. However, the limit of withdrawal on annuity plans is understandable as you are saving for retirement and minimum withdrawals can help you to accumulate a larger corpus over the period.

Now, let's come to the taxation part. There is no tax on investment in annuity or mutual funds. But during the annuitisation period, the amount that you receive as a pension is taxable in the hands of individual and is taxed as per the individual's income tax slab. However, in equity mutual funds, after one year, your tax liability would be 10 per cent, provided your gain is above Rs 1 lakh. For a period of less than one year, the tax on gain is 15 per cent. In case of debt and other non-equity funds post three years, you would be liable to pay 20 per cent tax on gains with indexation benefit. In case the holding period is less than 3 years, your gains would be taxed as per the individual tax slabs.

Therefore, mutual funds are more tax-efficient as compared to annuity plans as the tax is applicable on the gains and not on the principal amount invested. In the case of annuities, you are liable to pay tax even on the principal amount.

Let us take an example to understand this better. Say, you are getting Rs 50,000 per month from the annuity plan. This means annually you are withdrawing Rs 6 lakh, which places you under the 20 per cent tax bracket.

On the contrary, let us assume you are withdrawing Rs 25,000 per month from equity funds and Rs 25,000 from debt funds every month. Then, on withdrawal from equity funds, you need to pay tax on the gain over and above Rs 1 lakh at a rate of 10 per cent. In case of withdrawal from debt funds, you need to pay tax at a rate of 20% with the benefit of indexation. In any case, this looks more tax-efficient than annuity plan.

Types of annuity plans

Deferred annuity : In deferred annuity plans, you pay premiums for a specified period and build a corpus to buy an annuity which would give you fixed periodic payments post specified period.

Immediate annuity : In immediate annuity, you have to pay a lump sum to buy an annuity, after which you will receive periodic payments which starts immediately as per the payment frequency opted by you. The frequency could be monthly, quarterly, semi-annually or annually.

Apart from the above two broad types, there are also other types of annuity plans as listed below.

Life annuity: Annuity payments are made to you for lifetime. After your death, the annuity payments stop.

Life annuity with return of purchase price: Annuity payments are made to you for lifetime. However, on your death, the purchase price at which you bought the annuity is returned back to your nominee.

Annuity certain: This is a guaranteed annuity, where the annuity is paid for a guaranteed period of say, 5 years, 10 years, 15 years, 20 years, etc. Once the guaranteed period is over, provided you are still alive, the payments are made for your lifetime. If your death occurs during the guaranteed annuity period, the annuity payments will still continue. The payments will stop once your guaranteed annuity period is completed.

Increasing annuity: As the name suggests, the annuity payments increase every year or for every frequency by a fixed rate. The increase can be at a simple rate of interest or compound rate of interest.

Joint life annuity: Annuity payments are made till the lifetime of the last surviving annuitant. This means that if the primary annuitant dies, the annuity payments do not stop. The payments will continue for the lifetime of the secondary annuitant and vice versa.

Joint life annuity with return of purchase price: It is similar to the joint life annuity. The only difference is that in case of death of the last surviving annuitant, the annuity payments stop and the purchase price is returned to the nominee.

Conclusion
To sum it up, while planning for your retirement, you would be better placed with investing in MFs rather than annuities. The reason being the distinct advantage offered by mutual funds in terms of liquidity, returns and tax efficiency. Liquidity because annuity have limitations on withdrawals, whereas mutual funds do not have any such restrictions, apart from the exit load, if withdrawn before the specified period. Returns on mutual funds are better than that of annuities. Moreover, in the case of annuities, you lose flexibility of switching insurance companies as you need to compulsorily switch funds only within the insurance company from whom you have taken the annuity. However, in the case of mutual funds, you can exit the fund which is not performing and switch to a better fund, irrespective of the fund of the AMC you had invested in. Even in terms of taxation, mutual funds are more tax-efficient than annuities as when you start receiving annuity in the form of pension, the amount is taxable and the full amount is taxable in your hand, whereas in the case of mutual funds, only the gain is taxable and not the principal amount. Annuity is good for a risk-averse person who expects to receive guaranteed returns.