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Everything You Need To Know About Annuity
Table of Contents
- Everything You Need To Know About Annuity
- 1. What is an Annuity?
- 2. How does an Annuity Plan work?
- 3. Life insurance vs Annuity
- 4. Types of Annuity
- 5. Benefits of an Annuity Plan
- 6. Who should have an Annuity Plan?
- 7. What are the Tax Implications of An Annuity Plan?
- 8. Some Disadvantages of an Annuity Plan
- 9. Conclusion
Everything You Need To Know About Annuity
Every financial planning is done keeping in mind our future goal, it can be a dream home, a luxurious car, a big fat Indian wedding, or a child’s education, but apart from this financial independence and security should be our primary priority.
But, what we do is apart from planning our financial independence, we focus on every other goal. And ignoring the most crucial aspect like financial security is a sin. Through this article we want our readers to understand that they cannot afford to commit this sin. Financial security is inevitable and cannot be left behind at any cost.
And as in the previous article, we discussed the importance of retirement planning as a way of financial dependence. We want our readers to know more about this, and know how they can achieve financial security and independence through the various plans available in the market.
Let’s get started.
To make you thoroughly understand annuity, let's suppose that you filled a jar with candies in a single go, and now you are guaranteed that you will get a particular amount of candies at regular intervals for the rest of your life, no matter if those candies are over. This is something like an annuity plan, but with some more additions to it.
1. What is an Annuity?
An annuity is an agreement between an insurance company and an individual to give periodic payouts to the individual in exchange for the lump sum amount or as a series of payments paid by him/her. These payments can be made either immediately after making the investment or at a pre-decided future date
Now, let's simplify this.
While planning for some future fixed income source, let’s say for your retirement, you can consider an annuity as a great option. In this, you will invest a lump sum amount with your insurance company, and your investment with that company will now be the source of your fixed income, either this can be a source of income immediately after choosing the plan, or in future, whatever you decide.
So, an annuity is a pension product, through which you can put your hard-earned money to work for you, to meet your long-term retirement goals.
2. How does an Annuity Plan work?
Annuities are designed in such a manner that they can help you generate a steady cash flow during your post-retirement life.
2.1: When you invest a lump sum amount with your insurance company, then that company invests your money and gives you the returns it generates from that.
2.2: The invested corpus is illiquid, and if you want to withdraw your investment, then there would be penalties.
Life insurance corporations are the primary companies offering annuity plans, and an annuity is often known as the opposite of a life insurance policy.
But, you may ask, why? So, here is the answer.
3. Life insurance vs Annuity
3.1: A life insurance policy ensures that your loved ones are financially secure, even when you pass away. The risk for the insurance company in this is mortality risk, that is that you will die prematurely, which will bring loss to the company.
3.2: Whereas, an annuity plan ensures your financial security and helps you with a consistent stream of income that you can rely on for the rest of your life so that you don’t outlive your assets. The risk for the insurance company in this is that you will outlive the amount you have invested in the plan, and this will harm the company’s financials.
4. Types of Annuity
There are a number of annuity plans to choose from, let’s explore them one by one.
4.1: Fixed Annuity
This plan of annuity ensures that the payment payouts will be fixed throughout the time framework of the plan. This is somewhere chosen by those who believe in the traditional approach, i.e., they don’t want to risk anything. As a result of this, the returns of this plan are modest, which means that the development in your invested corpus will be not much.
4.2: Variable Annuity
This annuity contract is directly exposed to the performance of the underlying assets of your investment. Bonds, stocks, mutual funds or money market funds, are some of the avenues in which your invested amount will be invested. So, the payouts that you will receive will be based on your portfolio performance, i.e., your payouts will be variable.
4.3: Deferred Annuity
In this annuity plan, the payouts to you by your insurance company will start after a certain time. This annuity allows your investment to grow before you start to receive the payouts.
4.4: Immediate Annuity
In this annuity plan, there is little difference between the accumulation phase and the disbursal phase. This plan is usually best for those who are on the verge of getting retired.
5. Benefits of an Annuity Plan
5.1: Reliable Source of Income
You are promised of lifetime consistent and reliable source of income if you have an annuity plan.
5.2: Tax-Savings U/S 80C & 10(10D)
Under Section 80C and 10(10D), the amount paid towards the premium is deductible up to Rs. 1.5 lakhs.
5.3: No Investment Cap
Unlike other retirement schemes available like the Senior Citizen Savings Scheme, or POMIS, there is no investment limit in the case of annuities.
6. Who should have an Annuity Plan?
Anyone who is looking to plan their retirement, and to have a consistent source of income without working, can go for an annuity plan. It offers a sense of security with payouts that can be either monthly, quarterly, half-yearly, or annually.
Annuities come with the purpose to convert lump sum amounts into a stream of income. The amount of monthly lifetime payments will be determined by your age at purchase and your life expectancy.
However, an annuity should not be your sole source of retirement income, as over the years inflation reduces its value.
Most of the annuity plans allow you to start investing at the age of 18, also, annuities are the safest way of investment, thus giving modest returns. So, someone younger who can afford to take risks should not go for the annuity contract.
7. What are the Tax Implications of An Annuity Plan?
An annuity is treated as regular pension income, and the annuity that is received at regular intervals is treated as regular income and is taxed as per the income slab.
8. Some Disadvantages of an Annuity Plan
8.1: Modest Returns
An Annuity plan offers comparatively lesser returns than other market-linked schemes available in the market.
Annuity plans are managed as retirement plans, and just like other retirement plans, the investment done by the insurance corporations are mostly in long-investment horizons, and because of this premature withdrawals are penalized.
The Management fees and the sales commission involved, makes the purchase of annuity plans pretty much high.
Retirement is a critical part of our life, and to plan for that part you should explore different options and avenues. And while searching for that, you will find annuity being discussed a lot.
The amount you need to invest in an annuity will be based on the amount you need for your retirement corpus, and to calculate that you can refer to our previous blog, ‘Why, When, and How Should You Plan Your Retirement?’
And we hope you got a good amount of knowledge from this read.
Frequently Asked Questions
Deferred annuities are like immediate annuities where payouts can be received whenever the policyholder decides to do so.
No, a fixed annuity plan does not invest in the stock market.