Retirement planning 101: Why you shouldn't shun annuities - explained

For most retirees, the most important financial goal is to ensure they don't run out of money in their sunset years. The transition from earning a salary to depending on one's savings can be unsettling. After decades of saving and investing, one wants stability, not stress.

Till one retires, the focus is on accumulating wealth. But after retirement, it shifts to using that wealth prudently to meet expenses without eroding the corpus too quickly. This change requires a different investment mindset.

Equities, for instance, are undeniably powerful wealth creators. Over long periods, they beat inflation and deliver superior returns. But they also come with volatility. The prospect of investing one's retirement corpus in equities can be daunting. One sharp downturn can wipe out a big chunk of the savings and set back the retiree's plans by years.

Fixed-income instruments such as bank deposits and bonds are safe and offer predictability of returns. But even interest rates tend to fluctuate. Moreover, they are unable to beat the march of inflation.

What looks like an attractive return today may not hold 5-10 years down the line. More importantly, fixed-income options do not provide income assurance for life. Once the deposit matures or the bond is redeemed, the retiree must reinvest at whatever rates prevail at that time. Often, those rates tend to be lower.

This leaves retirees in a bind. They want safety, but they also need certainty of income. That's where annuities fit in. An annuity is a contract with a life insurance company where you invest a lump sum and, in return, receive a pension for life. Depending on the option chosen, the income can continue for as long as the annuitant lives, and in some cases, even for the lifetime of the spouse.

The biggest advantage of annuities is their longevity protection. People are living longer than ever before. That's a positive trend but also poses a financial challenge. A person retiring at 60 today could well live for another 25-30 years. Planning for such a long post-retirement period is difficult because no one knows how long they will live or how their expenses will change. An annuity removes that uncertainty by ensuring a monthly inflow for as long as one lives.

An annuity, on the other hand, offers income for life. "An annuity transfers the risk of longevity from the buyer to the insurance company. It gives the assurance of regular income till the end of one's life," says Rohit Shah, Founder and CEO of Getting You Rich Financial Planners.

The psychological comfort of this assured income cannot be overstated. It means the retiree can plan monthly expenses, healthcare costs, and leisure activities without the constant fear of the money running out. For decades, salaried individuals get used to the rhythm of a monthly paycheque. When that stops, it creates anxiety, even if one has a large corpus. An annuity reinstates that rhythm by providing a monthly pension.