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Friday, April 1, 2016

Annuity Plans

Despite the recent reduction in service tax, returns from annuity plans remain too low.
Finance Minister Arun Jaitley, in line with his vision of creating a pen sioned society, took two steps in this direction in the Union Budget.

He allowed withdrawal of 40% of the NPS corpus upon maturity without any tax. And, he waived off the service tax, payable at the time of purchasing annuities, for those buying it through their NPS corpus.

While the Finance Minister seems to be encouraging the purchase of annuities, experts advice against investing in them. Annuity is not the best option available now, because it is taxable and the rates offered are very low.Things may improve in the future, if the insurance companies increase the annuity rates," .

Taxable annuity rate of 6.75% offered by return-of-premium policies--policies which return the premium paid by the policyholder to the legal heir, upon his death--is significantly less than the 7.65% offered by tax-free bonds. Though the rates offered by policies without the return-of-premium rider are better, at around 9%, they still offer less than the 9.3% given by the Senior Citizen Savings Scheme (SCSS). Not only does the SCSS offer a better return, you also get to keep your principal.

Also, the return you get from annuities will get a further cut, due to service tax--if you aren't buying it using your NPS corpus.Though Jaitley has reduced the tax from 3.5% to 1.4%, it is still high. We are happy with the reduction and hope the government will refine it further in future. If you are buying a `10-lakh annuity, your actual investment, after paying the service tax, will be `10.14 lakh and the yield on the actual cost of return-of-premium policies will come down to 6.67%. Taxing annuity purchase is like taxing the principal at the beginning of an investment. If the government wants a pensioned society, it should withdraw this unjust tax.

Investors who have bought pension plans

from insurers are in a particularly unenviable situation. According to the Insurance Regulatory and Development Authority rules, pension plan investors have to compulsorily use 67% of the accumulated corpus to buy an annuity, and that too from the same insurer they bought their pension plan from. This is a real handicap as investors do not have the option of buying the annuity from another insurance company, which might be offering better rates. NPS investors too have to use 40% of their accumulated corpus to buy annuities. The only advantage is they have the option of going with the best annuity provider.

Annuity alternatives

There are several options to get a regular income for investors who have accumulated a retirement corpus--through EPF, PPF, mutual funds, etc. The SCSS is currently the best option available to senior citizens for a regular stream of income after retirement. They can invest upto `15 lakh in this scheme. Individuals falling in the 55-60 age bracket are also permitted to invest in the SCSS, provided they have retired from service. They also need to open the SCSS account within one month of receipt of retirement benefits and the amount invested cannot exceed the retirement benefits. SCSS is a good product and investors should consider parking `15 lakh of their corpus in it.

Retirees who continue to be in the higher tax brackets should consider investing in tax-free bonds. These bonds offer an interest rate of 7.65%--longterm FD rates offered by banks such as SBI stand at 7.25%, and FD is also taxable. Some listed tax-free bonds in the market offer even better returns. Continuing with debt funds and withdrawing money gradually using the systematic withdrawal plans (SWP) is another option for retirees. SWP will work better because it offers tax advantages. The long-term capital gains from debt funds, withdrawn after three years, will be taxed at 20% after adjusting for inflation. If one assumes that the future rate of return will be around 8% and inflation will grow at 6%, you will have to pay 20% tax only on the remaining 2% of the gains. In other words, your rate of return after tax will be around 7.6%.

Investors should look at the most suitable alternative to annuities to get the best return on their investment.

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