Retirement Income: Government Bonds Vs. Immediate Annuities

Government Bonds and Immediate annuity plans are two low-risk income options during retirement. Which is better? How can you use these products in your retirement portfolio?

You have recently retired and are looking for low-risk income options. Yes, you have bank fixed deposits. What are the other options?

Two low-risk products that come to mind.

1. Government bonds
2. Immediate Annuity plans

Government bonds are offering decent returns currently. I concede “Good” is subjective. You can now buy Government Bonds through your broker or through RBI Retail Direct platform.

Alternatively, you can invest in annuity plans from insurance companies. In an annuity plan, you invest a lumpsum amount and the insurance companies guarantees you income for life.

Government Bonds Vs Annuity plans

With Government bonds, you can lock-in the rate of interest for the duration of the bond. Up to 40 years. You can choose the duration based on your requirements. No need to worry about interest rates going down. You have been able to lock-in the rate of interest for a very long time. But not for life. When the bond matures, you will be exposed to reinvestment risk. With annuity plans, you lock in the rate of interest for life.

With Government bonds, there is no credit risk. Can’t say the same for annuity plans. However, if you are buying the annuity plan from LIC, there is almost no credit risk.

On the tax front, there is not much to choose. Interest income from Government Bonds gets taxed at your marginal tax rate (income tax bracket). Same treatment for annuity income from annuity plans.

Hence, no difference on the tax front.

Liquidity-wise, you can sell Government Bonds on the secondary market whenever you want. However, finding the seller can sometimes a challenge. In annuity plans (only in with return of purchase price variant), you can surrender the plan by incurring a penalty.

From interest rate perspective, Government bonds will likely offer a better return than annuity plans WITH return of purchase price, but lower than WITHOUT return of purchase price variant.

Two variants of Annuity plans

Annuity plans come in 2 primary variants.

1. WITH return of purchase price: You invest in the plan. You get the income as long as you are alive. After demise, the nominee gets back the investment amount.
2. WITHOUT return of purchase price: You invest in the plan. You get the income as long as you are alive. After demise, the nominee DOES NOT get anything back.

In Option (1), since the insurance company must be return the principal (investment amount), the annuity rate is linked to the prevailing interest rates in the economy and keeps changing. But once you invest, you are indifferent to subsequent changes.

In Option (2), the insurance company does not have to return the principal. Hence, it is more a play on how long you are going to live. Mortality tables and actuarial skills.

Long story short, since the Option (2) does not return the investment amount, it pays higher interest than Option (1). Sometimes, much higher.

The following are the rates for LIC Jeevan Akshay VII. For a purchase price of Rs 10 lacs.

 

Invest in Government Bonds or Annuity plans for Retirement income?

You retire at the age of 60 years.

I make the following assumptions.

1. You want a product that pays you regular income. AND
2. You want to reduce reinvestment risk i.e., lock-in the rate of return for the next 30 years or more.
3. No credit risk (so only Government and LIC products)

Here are 2 options worth looking.

1. If you want to guarantee yourself an income stream for up to the age of 90 years, you can simply buy a 30-year Government bond. And relax. After 30 years, you will get your money back. OR
2. You could buy an annuity plan (with return of purchase price). LIC Jeevan Akshay VII is one such product. With such plan, you will be able to lock-in the rate of interest for life.

The long-term Government bonds will likely offer a better interest rate than an annuity plan with return of purchase price.

How can Annuity plans then add value?

Since Government Bonds offer better returns, shouldn’t you simply buy Government Bonds?

Two points.

Firstly, annuity plans can guarantee you an interest rate for life. Government Bonds can guarantee for a long time but not for life.

Secondly, we have completely ignored the Annuity plans WITHOUT return of purchase price. Now, such annuity variant can provide a much higher income.

LIC Jeevan Akshay VII gives 10.89% p.a. for life to a 70-year-old. 17.59% p.a. to an 80-year-old (Source: LIC website, As on July 7, 2022). These rates are much higher than prevailing Government bond yields. The only caveat is that your nominee won’t get anything back after you are gone.

Most people stay away Annuity plans without return price. General refrain against such plans is: What if I die within a few years? Even the principal won’t come back. Yes, that’s a risk but the merits outweigh the risks.

Annuity plans without return of purchase price can create immense flexibility in your financial planning. You can earn higher income at low risk and can invest more freely. What else do you need during retirement?

So, the right variant at the right age.

You don’t have to choose just one

An example here.

At the age of 60, you buy a 10-year Government Bond. At that age, Annuity plans without return purchase price won’t offer a very high return.

At the age of 70, you can invest a portion of the bond maturity amount in annuity (without return of purchase price).

You can also stagger annuity purchases. This is quite interesting and I have discussed the benefits of staggering annuity purchases in this post.

There are alternatives to Government Bonds. You have RBI Floating rate bonds, Pradhan Mantri Vandana Vaya Yojana (PMVVY) and Senior Citizens Savings Scheme (SCSS). All these products are backed by the Government of India. No credit risk.

Good interest rate (in line with 10-year Government Bonds).

Medium-to-long duration. RBI Bonds (matures in 7 years), SCSS (5 years) and PMVVY (10 years).

Then, there are bank fixed deposits too.

Thus, there is a whole host of low risk-income options to generate retirement income. My limited experience is that annuity products get a cold shoulder. Annuity plans are better than that. But you must buy the right variant at the right age.

Be open and rational. Look at your income requirements and then choose a product (or a mix) that can meet those requirements.

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