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Annuities enable people to receive a fixed sum per month against a lump-sum investment and are used to earn a monthly pension. In other words, an annuity is a contract between you and an issuer under which you give the issuer a lump-sum amount and in return, the issuer guarantees you fixed monthly payments over time.

In most of the pension plans, on maturity, the corpus accumulated over time is used to buy an annuity for monthly pension. However, the monthly inflow received as pension gets added to the taxable income and gets charged to income tax at the rate applicable to the investor. These annuity plans issued by life insurance companies at best yield around 7% a year and that too taxable. Also, service tax is levied at the time of buying an annuity which further reduces the returns. Most of the annuities don't provide an early exit, in case an emergency arises.

A smarter way of planning a pension for your retirement years is to invest the lump sum amount in debt schemes of mutual funds and use the facility of 'Systematic Withdrawal Plan' (SWP) to receive a monthly pension. SWP is a facility wherein every month, on a pre-specified date, a fixed, pre-specified amount is withdrawn from the designated mutual fund scheme and credited to the investor's account.

A client of mine, Vijay (name changed), came to me in February 2012 with an investible amount of Rs 1.5 crore and wanted a post-tax monthly withdrawal of Rs 1 lakh. He invested Rs 1.385 crore in the growth option of medium term debt funds which have now grown to around Rs 1.52 crore. The remaining Rs 11.50 lakh was put in the daily dividend reinvestment option of ultras short-term debt funds and a SWP of Rs 1 lakh per month for 12 months from this ultra short-term fund since April 2012. With the last withdrawal in March 2013, the balance in the ultra short-term fund would get exhausted.

The investment in the medium term debt fund has completed one year and Vijay has started an SWP of Rs 1 lakh per month from this scheme, effective April 2013. Since the medium term debt funds on an average deliver around 9% yearly return which is broadly in line with the inflation index under the Income Tax Act, it results in almost nil taxable capital gain on the units sold for the SWP. Also, since the investment is over one year old, in case of emergencies, Vijay can withdraw the required fund without any exit load.