For years, NPS subscribers did not have much of a choice when they retired. A minimum of 40% of their retirement savings (corpus) had to be invested in an annuity. That’s all. The Pension Fund Regulatory and Development Authority (PFRDA) has recently made changes to the exit rules for private-sector employees who are subscribed to the NPS. The new rule allows private-sector employees to invest as little as 20% of their total corpus in annuities. This gives private-sector employees more freedom in how much of their corpus they want to receive as a lump sum. More freedom is always great, but it also creates more responsibility. Private-sector employees who retire will not only need to decide if they want to reduce the amount of their corpus that is invested in annuities; they will also need to decide if they should increase the amount of their corpus that is invested in annuities.
The 20% Rule Gives You More Choice, Not a Target
The new regulations provide a lower limit for the amount that can be placed in an annuity as opposed to a recommended level. While you may place as little as 20% in an annuity, there is nothing to suggest that this would be suitable for each individual. You are still able to select to place 40%, 60% or even 100% of your corpus into an annuity. What percentage you select depends on several factors including: your monthly expenses; other forms of income you receive; your health; and your ability to manage a large lump sum on your own over the next 25-30 years.
What Does Annuitizing Actually Mean?
When you annuitize, you hand a portion of your corpus to a life insurer in exchange for a regular income, usually paid every month, for the rest of your life. Once you buy, the rate is locked in and the payments don’t change with the market. Most annuity plans come in different forms, such as income for your life only, income that continues for your spouse after you, or income where the purchase price is returned to your nominee at the end. The trade-off is that the money you annuitize is generally no longer available as a lump sum.
Why Private-Sector Retirees Are Different
Most private-sector employees are not entitled to a guaranteed lifetime income after retirement like many public-sector workers. In addition to a modest amount of EPS pension that some will receive, the only financial support that most private-sector workers will have is their NPS corpus, EPF and personal savings. Unlike with a guaranteed lifetime income, there will be no monthly check from your employer when you retire. Therefore, having a guaranteed lifetime income is more important to you than it would be to someone who has a defined pension.
How Much Monthly Income Does 20% Really Buy?
Take an illustrative example. Say your NPS corpus is ₹1 crore and the annuity rate you get is 7% a year. If you annuitize the minimum 20%, that’s ₹20 lakh, giving you about ₹11,700 a month. At 40%, you’d get about ₹23,300 a month, and at 60%, about ₹35,000. Actual annuity rates depend on your age, the type of annuity, and the insurer at the time you buy, so check real quotes. But the example shows how little regular income the minimum may provide on its own.
Cover Essential Expenses With Guaranteed Income
A useful way to decide is to split your spending into two parts. Essentials like food, utilities, rent or maintenance, medicines, and insurance premiums should ideally be covered by income that never stops, whatever the markets do. Everything else, like travel and gifts, can come from investments. Add up your guaranteed income from EPS, any rental income, and annuities. If it falls short of your essential costs, annuitizing more than 20% can close that gap. For instance, covering ₹40,000 a month of essentials entirely through an annuity at 7% would need a little under ₹69 lakh.
When Does Annuitizing More Make Sense?
It usually makes sense if you have no other regular income, if you want certainty and would rather not manage a large investment portfolio yourself, or if longevity runs in your family and you worry about outliving your savings. It also helps if you want to protect a spouse. A joint life annuity keeps the income coming for them after you’re gone, which removes a big worry for many couples.
Reasons to Keep It at 20%
There are good reasons to stay at the minimum too. Annuity income is usually fixed, so inflation eats into it every year. Money kept as a lump sum stays flexible for medical emergencies, helping children, or other large costs. If you’re comfortable investing, a mix of debt funds, Senior Citizens’ Savings Scheme deposits (up to ₹30 lakh), and some equity can potentially give better long-term returns. And if your health is poor, locking in a lifelong income may not give the best value.
Which Type of Annuity Should You Choose?
If you decide to annuitize more, the type matters as much as the amount. A life annuity with return of purchase price pays a bit less each month but leaves the original amount for your family. A joint life annuity protects your spouse. Some plans offer an income that increases by a set percentage each year, which helps against inflation, though it starts lower. The best annuity plan in India for you is the one that fits your family situation, not simply the one with the highest headline rate.
How the Tax Works
Annuities provide fully taxable income that can be added to your income annually based on your slab rate. At present, the tax laws state that up to 60 percent of the NPS corpus that is withdrawn in a single payment (lump sum) upon retirement will not be subject to taxation. However, since the new regulations permit the withdrawal of up to 80 percent, you need to find out how the portion of the corpus that exceeds 60 percent will be treated under the tax laws prior to making a decision; different tax laws may apply. If it is found that the portion exceeding 60 percent is indeed taxable, then you could potentially avoid paying taxes on your entire lump sum by annuitizing at least 40 percent.
Most people who retire from their jobs in the private sector will find that the amount of money they should receive each month through a lifetime annuity is the amount that is required to pay for all of their necessary monthly expenses. In many cases, this is greater than the required 20% minimum. To determine how much of your retirement savings you need to use to buy an annuity, calculate what your essential costs are, total up all of your other guaranteed sources of income, and then buy an annuity with the remaining portion of your retirement savings to cover the difference between your guaranteed income and your essential costs. You can continue to invest the remainder of your retirement savings as you choose.
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