While the Budget is proposing to tax 60% of the withdrawal of the employee’s provident fund corpus unless it is converted into an annuity plan, it’s important to keep in mind most such products offer interest rates of 6-7% and, unlike many other schemes, these returns are taxable.
In the case of the public provident fund, for instance, not only is the interest rate of 8.7% significantly higher, there is no tax applicable on this — for someone in the 30% tax bracket, this means the annuity gives an effective post-tax return of 4.6% versus 8.7% for PPF. In the case of national savings certificates, the interest earnings are taxed in the same way that annuities are, but the earnings are a significantly higher 8.5% (see table: Sop Soup on page 1).
An annuity, as the name suggests, is a guaranteed amount paid for a subscriber’s lifetime — there is an option to extend the pension to the spouse and even return the corpus to the child, but this lowers effective returns — in return for a one-time payment. Currently, Life Insurance Corporation of India offers a monthly annuity of Rs 745 on a payment of Rs 1 lakh if bought at the age of 60 with no payments to be made after the subscriber’s death. In case the payment has to be extended to the spouse, this monthly annuity reduces to Rs 644.
There are several reasons for low returns from annuities. Typically, short-term interest rates are higher than long-term rates. By definition, annuities are long-term payments and so cannot match high short-term rates. The other problem is the unavailability of very-long-term corporate bonds in the country, which can generate better yield than those offered by safe but low-yielding government bonds. As a result, insurers have to park most of the annuity corpus in long-term government bonds.
Not surprisingly, annuity products do not account for a high proportion of the insurance business. In FY15, a little over 17% of the total investment made by insurance companies in India was on account of annuities compared with 16% for unit-linked funds and 67% for life funds — the last two products are tax-free.
While insurers offer various type of annuity products ranging from pension for life, pension to spouse on the death of the annuitant, there is no provision for surrendering the policy in case of any requirement for money for any emergency.
Even in policies with return of the corpus, this will be returned to the heirs of the investor only after his or her death.
Even insurers are also very rigid in changing the annuity option if the investor wants to do so.