Annuities

Chapter 3 established that at least 40% of an NPS corpus must buy one. This chapter is what you are buying, because it is the least understood product most Indians will ever purchase — and the purchase is irreversible.

What it is

You pay an insurer a lump sum. They pay you an income for as long as you live.

That is the whole product, and the phrase doing the work is for as long as you live. Everything else about an annuity is a variation on who bears the risk of that being longer or shorter than expected.

Under the NPS, annuities are bought from an Annuity Service Provider empanelled with PFRDA — fourteen were empanelled at the time of writing — and you choose which.

The one thing it does that nothing else does

It removes longevity risk.

Every other retirement arrangement has the same unanswerable question underneath it: how long does this money have to last? Chapter 5's withdrawal rate is an attempt to manage that with arithmetic. An annuity answers it by transferring the question to somebody else.

If you live to 95, the insurer keeps paying. If you live to 68, they stop and keep the balance. You have bought insurance against living a long time, and like all insurance it looks like a bad deal in every scenario except the one it was for.

That is a genuinely valuable thing and it is why the product exists.

What it costs

Three costs, and the first two are usually unstated.

You give up the capital. For a plain life annuity, the money is gone. Your heirs receive nothing, and you cannot change your mind — which is a different relationship with your own money than any other instrument in this course.

The payment is usually fixed in nominal terms. Chapter 11 of the Fixed income subject applies in full: a fixed payment loses purchasing power every year, and over a thirty-year retirement that erosion is severe. An annuity paying comfortably at 60 may be paying inadequately at 85, which is precisely when flexibility is least available.

The rate is set on the day you buy. The income is determined by prevailing rates at that moment and then fixed for life. Buying when rates are low locks in a low income for thirty years — chapter 3 of the Fixed income subject's seesaw, arriving as a permanent decision rather than a temporary price.

The variants, and the trade

Every variant trades income for something else. The arithmetic is unavoidable: more protection means a smaller payment, because the insurer is bearing more.

Life annuity. Highest payment, nothing to heirs, ends on death.

Life with return of purchase price. Lower payment, and the original lump sum returns to your nominee on death. Popular in India for obvious reasons, and the reduction in income is the price of that.

Joint life. Continues to a surviving spouse. Lower payment, and for most couples the one that actually matches the need — the risk being insured is that either of you lives a long time.

With a guaranteed period. Pays for a minimum number of years regardless.

Increasing annuity. The payment rises at a stated rate each year. Starts much lower, and it is the only variant that addresses the inflation problem directly.

There is no best variant. There is the one that matches whether you are protecting yourself, a spouse, or an estate — and those are different questions with different prices.

How to think about the decision

Four things, in order.

Shop the rate. Fourteen providers quote different rates for the same money and the same variant. The difference persists for life, and this is a few hours' work with a permanent payoff.

Prefer joint life if you have a spouse. The arrangement most couples actually need, and the single-life rate on one head is a common and expensive error.

Use the deferral. Chapter 3: the NPS lets you defer the annuity purchase to 75. If rates are poor at 60, you are not obliged to buy at 60 — and chapter 7 is why that option is worth holding.

Annuitise part, not everything. The 40% minimum is a floor rather than a target. Covering your essential spending with guaranteed income and leaving the rest invested gets you the longevity insurance where you need it and keeps the growth and flexibility elsewhere. Chapter 8 builds this.

The honest summary

An annuity is insurance, not an investment, and judging it as an investment makes it look poor — the implied return is modest and the capital is gone.

Judged as insurance, the question is different and better: what does it cost me to never run out? For the portion of your spending that absolutely must continue regardless of how long you live or what markets do, that is a price worth paying.

For the rest, chapters 5 and 6 are the alternative.

The point

An annuity converts a lump sum into income for life, which is the only way to remove longevity risk. The costs are the capital, a payment usually fixed in nominal terms against decades of inflation, and a rate locked on purchase day. Shop between providers, prefer joint life if you have a spouse, use the deferral if rates are poor, and annuitise your essential spending rather than everything.