Deferred Annuities: Income Certainty, But Inflation Risk Ignored

While both deferred annuities and mutual funds or market-linked products like NPS serve different yet kindred purposes, they each play separate and complementary roles; mutual funds and NPS are generally intended for growing wealth and typically have greater potential for growth over long time periods, including the possibility of market volatility.

“Conversely, deferred annuities focus primarily on providing investors with a guaranteed income, which cannot be replicated by other types of market instruments but can be created from the total amount of accumulated savings at retirement. As a result, many retirement plans utilize both deferred annuities for income stability and market-based instruments for wealth generation,” says Arun Ramamurthy, co-founder, Staywell.Health.

Guaranteed Income Comes With Inflation And Liquidity Trade-Offs

The primary risks include inflation risk, as fixed annuity payouts may lose purchasing power over time. “There are also liquidity limitations, since funds are usually locked in for long durations with restricted withdrawal options or surrender charges.

In addition, insurer credit risk is an important consideration, as annuity payments depend on the financial strength and stability of the insurance company, making it essential to choose well-rated insurers,” says Rajani Tandale, senior vice president, mutual fund, 1 Finance, a personal finance advisory firm.

Key Risks To Assess Before Committing to Deferred Annuities

In deciding which options are best for each investor, there are several important factors to consider. These include the effect of inflation on fixed payouts, the liquid nature of the product relative to its long-term commitment, and the creditworthiness/capital strength of the issuer of the annuity contract, as the annuity's guaranteed payments depend upon the long-term viability of the issuing organization.

Before making an investment in a deferred annuity, an investor should understand the product's characteristics, the various payout options available under the contract, and whether or not, and how, inflation will affect the investment.

Who Deferred Annuities Are Suitable For 

Deferred annuities are best suited for conservative investors approaching retirement who want to secure a guaranteed income for essential living expenses. For example, in NPS, a portion of the retirement corpus is already converted into an annuity after the age of 60, highlighting the role annuities play in retirement planning.

“Allocating a part of retirement savings toward annuities via NPS can be beneficial, as several studies show that many retirees exhaust their corpus within 15 to 20 years, while life expectancy may extend 30 to 40 years or more. Therefore, having a lifelong income stream through annuities helps manage longevity risk effectively,” says Tandale.