Everything You Need To Know About Annuity

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.

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. 

Source: Hdfclife.com

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.

          8.2: Liquidity

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.

         8.3: Cost

The Management fees and the sales commission involved, makes the purchase of annuity plans pretty much high.

9. Conclusion

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.