India's evolving economic landscape poses both challenges and opportunities for retirees
India is the fastest-growing major economy in FY2023, as stated by the World Bank. It further goes on to declare that the country’s economic growth was the second highest among G20 countries. At the pace at which the country is developing, we will, in all probability, transition from being an emerging to a developed economy sooner rather than later.
This changeover from a developing to a developed economy will have an impact on interest rates as well, which in turn will impact the regular income of retired individuals as they run the reinvestment risk. So, what is the correlation between economic development, interest rates and reinvestment risk?
To understand this, let’s look at the flight path of interest rates in the US. Data from the Fed Rates chart shows the interest rates in the US were 10.89% in September 1984 and 5.07% in June 2023. Now let’s look at the trajectory of interest rates in India. As per the RBI, the interest rates in India were 12% in September 1994, two years after the announcement of economic reforms, fell to 8% in September 2014 and have since come down to 6.50% in June 2023. This clearly establishes the inverse relationship between economic growth and interest rates.
So how does this impact the income of retired individuals? Retired individuals look to receive guaranteed regular income not affected by market volatility. Typically, retirees invest in short-duration deposits, giving them a regular flow of income. These are renewable at periodic intervals and at the prevailing interest rate, which could be lower. This is commonly known as reinvestment risk.
Let us understand it in detail. For ease of understanding, the tax implications have not been considered in the example below.
Mr. Rajat Gupta, upon retiring, invested his accumulated savings of ` 60 lakh in short-duration deposits, at an interest rate of 8% p.a. This investment provided him with an annual income of ` 4,80,000 or ` 40,000 per month. Rajat was comfortable with this income and managed his daily expenses.
However, a few years later, when it was time to renew this deposit, he encountered a challenge. The interest rate had fallen to 6%, reducing his monthly income to ` 30,000. This 25% decrease in income impacted his lifestyle and left him with no option but to adjust to the reduced monthly income.
The real shock came when he had to renew his short-duration deposit. The third time, at an interest rate of 4%, his monthly income dwindled to a mere ` 20,000, half of what he was earning initially. This steady fall in interest rates affected his financial security.
Now let us see what would have happened had Rajat invested in an annuity product. Since annuity products lock-in the interest rate at the time of purchase, Rajat’s income would not be affected by volatility. So let us assume the interest rate was locked-in at 7%, he will receive a monthly income of ` 35,000 for the rest of his life, irrespective of interest rate movements. This clearly underscores the importance of ensuring guaranteed life-long income with annuity products.
How do annuities mitigate the reinvestment risk?
In this shifting economic landscape, annuity products enable individuals to receive lifelong guaranteed income at an interest rate fixed at the time of purchase. They present a compelling proposition of stability, enabling retirees to know their exact cash-flow making planning finances significantly easy. Also, annuity products are only offered by life insurance companies.
Let us understand the key attributes of annuity products and how they can offer individuals financial freedom in their golden years. Here is what makes them unique – Guaranteed Income for Life.
One of the persistent challenges of individuals is gauging the length of one’s retirement. With advancements in and access to better medical facilities, the average life expectancy in India has risen to 70 years and is expected to go up further. Effectively, this means individuals are expected to lead longer retired lives. Annuities offer guaranteed regular income for the entire duration of the individual’s life, alleviating the concerns of what if I outlive my savings.
Consistent and unwavering income
Annuities stand out for their provision of income resilience, independent of external financial turbulences. No matter the market dynamics or interest rate shifts, the income from annuities remains constant. This stability is anchored in the interest rate locked-in when the purchase is made.
Ensures income for spouse
Annuity plans come with a ‘Joint-Life’ option, providing financial security to the spouse. This feature ensures the partner receives the same income or pension after the demise of the primary annuitant or policyholder. Significantly, after the demise of the joint holder, the premium paid will be paid-out to the nominee. This, in a way, ensures legacy planning.
Flexibility to choose income start date
Annuities cater to diverse retirement needs by offering the ‘Immediate’ and ‘Deferred’ options. Immediate Annuities are best suited for individuals who are close to retirement as the guaranteed income commences immediately upon making the one-time premium payment. Deferred Annuities enable individuals to postpone the income start date while allowing their principal investment to grow over time.
Senior Executive Vice President,
ICICI Prudential Life Insurance Company Limited
Not all individuals may have the ability to make lumpsum payments to purchase an annuity product. With the changing social structure, retirement planning has assumed greater significance. To enable a larger section of the country’s population to plan for their retirement, life insurers have developed products which enable individuals to systematically make contributions over the long-term, build the desired corpus and receive guaranteed regular income. One such contemporary product is ICICI Pru Guaranteed Pension Plan Flexi.
India’s evolving economic landscape poses both challenges and opportunities for retirees. As interest rates trend downwards, proactive planning and informed financial choices, like embracing annuities, can ensure a secure and comfortable retirement.
