Retirement-focused products that promise certainty can look attractive.
The returns are guaranteed, and locking into a fixed rate feels reassuring at a time when deposit rates are declining.
'Invest Rs 1 lakh yearly, get Rs 2 lakh annually.'
Doesn't this also sound like a great investment?
You pay Rs 1 lakh every year for 15 years, and then receive Rs 2 lakh annually for the next 15 years, effectively doubling your investment.
If you are a salaried employee in your early to mid-forties, this may strike a chord.
One of your biggest worries perhaps is managing expenses after retirement.
Retirement-focused products that promise certainty can therefore look attractive.
Appeal of guaranteed returns
These products are simple, transparent and easy to understand.
The returns are guaranteed, and locking into a fixed rate feels reassuring at a time when deposit rates are declining.
They also come with a small life cover.
Their biggest appeal lies in clarity: You know in advance how much you will pay, how long you will pay, the deferment period, what you will receive once payouts begin, and for how long.
Even if brochures add features such as 'guaranteed additions', the essential structure remains straightforward enough to calculate what you will get and when.
You can also calculate your final returns in case you survive the policy term.
Problems with the pitch
The marketing pitch of 'Pay Rs 1 lakh, get Rs 2 lakh' can be misleading.
Unless you compute the internal rate of return (IRR), you may assume the offer is better than it is.
In reality, a longer premium payment term or a longer deferment period reduces the net returns, while extending the payout period does not change the IRR much.
Doing the IRR calculation helps you understand what you are getting into and decide whether the return is sufficient for a long-term product.
Doing this exercise will reduce the scope for disappointment later.
Remember that these are long-term contracts that are expensive to exit.
The deferment trap
The deferment period -- the gap between the last premium payment and the first payout -- is often presented in a way that creates confusion.
The brochure may say you pay for 10 years and start receiving income from the 12th year.
Since premiums are paid at the start of the year and payouts at the end, the first payment is effectively received only in the 13th year.
This gap of three years, instead of the two suggested in brochures, works to the insurer's advantage.
Different from annuities
Both these products and annuities are non-participating life insurance plans, but the crucial difference lies in risk.
With annuities, the insurer guarantees lifetime income and bears the longevity risk.
With these policies, the insurer pays only for a fixed number of years, so you run the risk of outliving your savings.
This makes them inferior to annuities in terms of protection, but they do have a tax advantage.
Annuity income is fully taxable at your marginal rate, whereas payouts from traditional insurance plans are exempt, provided the total annual premium across such policies does not exceed Rs 5 lakh and the life cover is at least 10 times the annual premium.
Should you invest?
Financial planning is rarely perfect. Sometimes a slightly sub-optimal product still makes sense if it provides peace of mind.
These policies may be considered for covering basic retirement expenses, though they should not form the entire retirement plan.
Inflation must be factored in, and other investments should be explored for growth and flexibility.
Disclaimer: This article is meant for information purposes only. This article and information do not constitute a distribution, an endorsement, an investment advice, an offer to buy or sell or the solicitation of an offer to buy or sell any securities/schemes or any other financial products/investment products mentioned in this article to influence the opinion or behaviour of the investors/recipients.
Any use of the information/any investment and investment related decisions of the investors/recipients are at their sole discretion and risk. Any advice herein is made on a general basis and does not take into account the specific investment objectives of the specific person or group of persons. Opinions expressed herein are subject to change without notice.
Deepesh Raghaw is a Sebi-registered investment advisor.
Feature Presentation: Ashish Narsale/Rediff
