Many individuals close to retirement are unfamiliar with buying government bonds vis RBI Retail Direct and how it differs from purchasing a life insurance pension plan*. We discuss the essential differences in this article.
In this article, a life insurance pension plan refers to an immediate annuity plan, not a deferred one. Always avoid deferred annuity plans!
Only retirees or those who need regular income should consider both products. Let us consider the essential differences.
Annuities vs Bonds
- Annuities pay as frequently as each month. Bonds pay interest twice a year.
- The annuity rate of interest depends on the age of the purchaser. So, the older the individual, the better the rate. This is the underlying idea behind annuity laddering: Use this annuity ladder calculator to plan for retirement with multiple pension streams. The bond interest rate is age-independent.
- At a young age (how young depends on prevailing yields and rates), bonds may offer a higher income than annuities. Older retirees may get a better deal with annuities. That is, annuity rates depend on age and is favourable for older retirees (and the insurer who are betting they will die sooner!).
- An annuity requires proof of life (aka life certification) each year. Bonds do not require this.
- An annuity can be held individually or jointly only with a spouse. A bond account can held individually or jointly with any other holder with valid KYC.
- Upon maturity or premature death, a bond returns the principal amount to the individual or the nominee. Annuity products have several options. Some involve the return of purchase price (this has a lower interest rate), and some don’t. See Higher annuity rates of LIC Jeevan Akshay applicable from Feb 2023. So, you will have to pay the insurer more to get the same pension as a bond or a simple annuity for life if you want the principal back.
- Annuities are subject to 18% GST, while bonds are not.
- Bonds are subject to reinvestment risk (newer bonds could have lower interest rates), while annuities can offer income until the lifetime of the younger spouse. Joint ownership minimises reinvestment risk, but we must choose the bond tenure carefully.
- The govt can recall a bond (that is, pay back the principal and stop interest payments) under exceptional circumstances. In principle, this can happen with an insurer too. However, it is reasonable to expect the chances of these events to be quite minuscule.
- Both options are illiquid. That is, you cannot get your money back after you have purchased a bond or an annuity (certain choices). In principle, one can sell REBI Retail Direct bonds via the secondary market, but buyers would be quite scarce, if not nonexistent. In LIC’s Jeevan Akshay, only options with a return of purchase price can be surrendered mid-policy for a fraction of the purchase price. So unless you are sure you need an income, do not buy either option!
- Bond yields keep changing, while annuity rates are reasonably stable. So the yield of new bonds can be higher after we purchase one, leading to regret of missing out (ROMO!).
- Combining bonds and annuities: A retiree can consider buying a bond for the first annuity if it offers a higher yield and then buy single/joint annuities after a decade or so when the rates would be higher.
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