In the previous week, we had reviewed some of the common investment products that people invest in to save for their retirement. 

 

We had narrowed down to a simple systematic investment plan in two mutual funds – one equity and one debt scheme – as the ideal way to save for retirement goal.

 

In this article, we will review the common products that retirees invest in to generate long-term, stable income.

 

1. NPS Annuity – people investing in national pension system (NPS) will have to compulsorily put at least 40% of their NPS corpus at retirement into an annuity. Annuities are insurance products that provide guaranteed lifetime income against purchase price. Annuities are compared on the yield they provide on the purchase price. For example, an annuity with purchase price of Rs 10 lakh which pays Rs 80,000 per annum for life is paying 8% yield. The higher the yield, the better the annuity.

 

Annuities stop paying income once the annuitant dies. In some annuities, income continues for the spouse after death of primary annuitant. Some annuities also return back the purchase price on death of annuitant – this is why it is the preferred choice of annuity among buyers. NPS subscribers have to buy annuities from any of the 12 empaneled annuity service providers i.e. life insurance cos.

 

Pros: simplest solution for retirement income. Several choices of annuity providers in the market. Wide variety of annuity income payouts for every need. Tax benefit on purchase price invested. Can use annuities for legacy and estate planning as well.

 

Cons: Yield is dismally low. Purchase price gets locked-in and cannot be taken back unless annuitant or their family is diagnosed with critical illness. Have to submit life certificate annually to continue receiving annuity income. Income earned is taxable at slab rate. Annuity income is constant for life, but inflation eats into the purchasing power. It requires crores to be invested in purchase price to get a decent annuity income. TDS is deducted if interest earned crosses Rs 50,000 per fiscal year.

 

2. Senior Citizens Savings Scheme – SCSS is a government-backed scheme for retirees to generate income. The scheme can be invested in at any post office branch, major private sector banks and all public sector banks. The maximum investment per person is Rs 15 lakh. People normally invest jointly with spouse, in two accounts, allowing a total Rs 30 lakh to be invested in the scheme.

 

The scheme works like a fixed-deposit, paying interest on quarterly basis, and matures in five years. The scheme can be renewed once for another three years. It can be prematurely closed anytime subject to penalty charge. 

 

The interest payable is announced every year and remains fixed for the entire 5-year tenure. Entry age in scheme is 60 years and for retired government and defense employees it is 55 and 50 years respectively.

 

Pros: Government-backed scheme. Better yield than annuities. Currently pays 7.4% p.a. which is around Rs 27,750 per quarter on investment of Rs 15 lakh. Recommended product by us. Tax benefit on invested amount.

 

Con: Interest is taxed at slab rate. Lack of clarity over reinvesting in SCSS after completing 8 years (5 year + 3-year extension). Available only to senior citizens.

 

3. LIC’s Pradhan Mantri Vaya Vandana Yojana – this is another government-backed product offered via public life insurer LIC. It works similar to SCSS i.e. like a fixed-deposit that pays interest. However, the difference is that PMVVY is a 10-year product. The current interest rate is 7.40% per annum monthly, same as SCSS.

 

The product can be purchased at LIC branch or online on the LIC website. Entry age is 60 years for buying this product. There is no joint account facility.

 

Interest is paid monthly, quarterly, half-yearly or yearly – as decided by the buyer. Loan is available against the investment. 

 

Pros: Good for long-term income planning. Offers high rate of interest. Government-backed. 

 

Cons: Interest (pension paid) is taxed at slab rate. Premature exit is allowed only under exceptional circumstance and subject to penalty charge. Available only to senior citizens.

 

4. Senior Citizen Bank Fixed Deposits – Bank fixed deposits offer special deposits with higher interest rate to senior citizens. Bank deposits tenure are available for 1 day to 5 years. Interest payment frequency can be modified as per depositor’s choice.  

 

Pros: Numerous public & private banks to choose from and diversify holdings. Competitive interest rates. Interest is fixed for entire term. Premature closure allowed. Recommended by us.

 

Cons:  Interest is taxable at slab rate. TDS is deducted if interest earned crosses Rs 50,000 per financial year. Safety of deposits is dependent on bank’s asset performance. Reinvestment risk due to shorter maximum tenure of 5 years only. Not suitable to enter during low interest rate cycle.

 

5. Debt mutual fund schemes – debt schemes offer a direct exposure to the wholesale debt market – where most debt securities get traded. The debt scheme fund manager pools money from investors and buys debt papers from various issuers. The investors are given units which are backed by the debt paper assets. The interest earned on the debt papers is reinvested into the scheme, to buy more debt papers.

 

Although debt schemes do not offer a fixed source of income, the same can be created via systematic withdrawal plans (SWPs). SWPs involve selling a given number of units each month to generate an income source. Debt schemes have dividend option, but it is taxed unfavorably and the dividend income is unpredictable.

 

Pros: tax-efficient because of capital gains taxation. Capital gains get taxed at very low rate once 3 years are completed in the scheme. Debt papers earn high post-tax returns compared to the above products. There are various choices among debt schemes, from least risky to risky ones for every investor. Every scheme diversifies its holding across 30-100 different borrowers to manage risks. No lock-ins so amount can be withdrawn anytime. Flexibility in withdrawals, can withdraw more if needed.

 

Cons: returns are market-linked and therefore require need guidance of investment advisor. Debt schemes holding risky debt paper do face defaults and losses from such holdings. Fund house quality matters, as sometimes a fund manager may enter into private deals with borrowers instead of buying market-listed bonds. Illiquidity issues occur during crisis, but can be averted by sticking to high rated debt schemes. Market-linked returns means low interest rates can lead to poor returns on schemes.

 

Senior citizens and income-seekers should use a mix of various products, but also avoid too many investments. Debt schemes should form the major portion of your income generating assets. Some exposure of 10% to 20% should be given to equities to hedge risk from fall in interest rates.