HDFC Life recently announced a new plan, the HDFC Life Pension Guaranteed plan. For an upfront investment of Rs. 50 Lakh, the plan promises to pay a monthly amount after a certain period of deferment. Upon death, the plan pays the original Rs. 50 lakh principal back to your nominee. The annual annuity rates range from 9% to 12% depending on the plan you choose. This seems too good to be true - getting 12%, as well as the original corpus back? What’s the catch?
The catch is that you’re not actually getting 12% per year. You’re actually going to make closer to 6% a year. This isn’t false advertising. But, it is somewhat deceptive.
Here’s how annuities work. You make an initial payment, and then some amount of money is paid out to you each year.
This HDFC Life policy falls under the 4th category in the infographic. As seen in the advertisement, you have an option to defer your investment by 5, or 10 years. After that, you receive an annual sum of money, and the entire principal is paid back to your nominee when you pass away. This sounds great - but why is it actually a bad investment?
It has to do with a concept called the time value of money. Rs. 100 today is worth more than Rs. 100 tomorrow. This is because you could invest that 100 rupees today, and have it become 101 by tomorrow. Furthermore, inflation means that as each day passes, that 100 rupees is worth less.
Let’s take the HDFC life example, where you start with Rs. 50 Lakh. Instead of putting it in HDFC Life, you put it into the debt markets, like liquid funds. And for simplicity’s sake, you invest at the most risk free rate of return possible, just 6%. Your 50 lakhs compounds in value, growing by 6% each year.
But HDFC Life pays out a fixed amount each year. In the 5 year deferment option, you get Rs. Rs. 4,36,776 each year. The tiny red column at the bottom of this graph? That’s what they pay out each year.
By year 30, your 50 Lakhs is actually worth 2.5 Crore. And you’ve been paid out a total of just... 1.6 crore. The difference has been made by HDFC. HDFC would do exactly what we outlined here - invest your 50 Lakh in a very safe set of investments, and with no risk, make plenty of money.
You can run these numbers yourself. Download our spreadsheet here.
This ad is an example of how we are misled by financial product advertisements. The ad is not false - but it is very misleading. A 9% annuity rate is very different from making 9% a year. And it is a good reminder that when we see ads for products like this, we should run the numbers ourselves before buying any product.