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What is Annuity: Meaning, Types & Benefits

Annuity plans offer the best retirement solution since they offer a fixed and assured income for the whole of the remainder of one’s financial years.

  • 5,641 Views | Updated on: Jul 03, 2024

Picture yourself standing at the crossroads of your financial journey, unsure which path will lead you to stability, certainty, and worry-free retirement. Whether you seek stable growth, tax benefits, or a balance between the two, there is an annuity plan that aligns perfectly with your needs.

In a world of uncertainties, an annuity plan is one of the most certain things you can rely upon. However, different types of annuity plans are offered in India based on the needs of an individual. Therefore, you must choose one which suits your financial needs perfectly. Let us understand the annuity meaning, its need, importance, benefits, and everything related to annuities.

What is Annuity Plan?

In simple terms, an annuity plan is a chain of periodic payments you receive from time to time from a lump sum amount previously paid by you.

For an individual, their other life assets might deplete over time for some reason or the other. Still, an annuity plan can offer the guarantee of assured income.

Different Types of Annuities

One can choose from a wide range of annuity plans based on their requirements. Each plan works differently. After understanding the annuity plan meaning, we will delve into some common types of annuity plans and how they work below:

Life Annuity

In this annuity plan, you will receive regular payments (monthly/quarterly/yearly) throughout your life.

Life Annuity with Return of Purchase Price

This plan is similar to Life Annuity, where you shall receive regular monthly payments. However, after your demise, the insurance company will pay your nominee’s initial investment (used to buy the annuity). You can consider this option if you want to pass on some finance to your loved ones after your demise.

Guaranteed Annuity

With a Guaranteed Annuity, you will receive regular income for a defined period of time (e.g., 5, 10 or 15 years). In case of your demise, your nominee will start receiving the same. Annuities will stop after the completion of your guarantee period or the demise of the annuity holder, whichever falls later.

Joint Life Annuity

With a joint life annuity, you can continue to enjoy the benefits of an Annuity plan throughout your or your spouse’s lifetime.

Joint Life Annuity with Return of Purchase

Similar to Joint Life Annuity, with this plan, after the demise of you or your spouse, the nominee will receive the original investment amount used to buy the plan.

Fixed Annuities

In its simplest definition, fixed or immediate annuity involves paying a fixed sum periodically for the whole span of the policy. This is the closed amount, which is decided, at the time of purchasing this policy. The amount paid to you is between 0.1 to 1.0 percent of the principal investment, with the lower limit guaranteed. It interfaces with the market but does not get influenced or shaped by the occurrences in this market.

Variable Annuities

In variable annuities, your premiums are invested in things like mutual funds or equities to receive well-known reallocations. Benefits from such plans are accorded based on the returns of the investment you make based on a particular fund. For instance, if the fund returns are high, you get higher passive income, and if they are low, then expect low passive income.

Benefits of Annuities

Here below are the pros of each of the annuity plans. This may assist in determining the proper course of action to meet the monetary requirements of the subject.

Guaranteed Income Stream

An immediate annuity plan provides income that is smooth and without any volatility in the later stage of life, i.e., during the retirement period. Thus, the objective of this plan is to help people maintain financial independence in their retirement age, providing people with stable earnings to pay for their needs.

Tax-Deferred Growth

One of the key benefits of annuities, particularly fixed and variable varieties, is that they are tax-deferred therefore the returns on the investment are not taxed until they are withdrawn. It means the investment will also be more effective in growing over time, the retirement fund will be better.

Flexibility in Payout Options

However, annuities have flexibility in the payout method, where people can select from the different income types. It comprises terminal payments, progressive payments or sometimes a mix of both, allowing for flexibility to meet specific financial objectives.

Long-term Care and Other Riders

There are even more benefits that come with additional riders such as long-term care coverage coming with many of the annuity plans. These riders help cover other unpredictable cost-of-living contingencies, especially in the area of health care making for complete security in retirement.

Legacy Planning

Legacy features can also be added to annuities which enable the annuitants to leave behind a financial body when they die. Some of the options offered by the annuity help guarantee that any remaining balance is given back to the beneficiaries, ensuring that the dependents are financially taken care of for generations.

Why Do You Need an Annuity Plan?

Here are a few reasons why an annuity plan is worth chasing:

  • Offers you a fixed income for the rest of your life, which means financial freedom with the help of a retirement annuity during your sunset days.
  • Flexibility to choose between monthly or yearly payouts.
  • Tax benefits are based on current tax provisions.
  • Ability to withdraw money after being diagnosed with a critical illness.
  • Flexibility for premium payments for your annuity plan offer.

How Do Annuities Work?

Annuities aim to reduce people’s concerns about outliving their assets by supplying a steady cash flow during their retirement years. Some investors may decide to purchase an annuity contract from an insurance company since their current wealth might not be sufficient to maintain their standard of living.

  • When you buy an annuity plan, you pay an insurance company or financial institution a lump sum payment or a series of payments. The annuity company invests this payment, referred to as the premium.
  • Your premium increases while it is being accumulated, deferring taxes. Your money is invested by the annuity provider, and the value growth of your annuity is based on how well these underlying investments perform.
  • Throughout the distribution phase, the annuity provides you with regular income payments. The payment schedule is governed by the contract’s terms. Some annuities allow you to choose to receive income for a predetermined period of time, such as 10, 15, or 20 years. Alternatives include lifetime payments, which are made as long as the recipient is alive.

Who Should Buy an Annuity Plan?

An annuity plan can be a good option for people who are looking for a guaranteed income stream in retirement. Here are some of the people who might benefit from buying an annuity plan:

People Close to Their Retirement

Annuities are a good option for people nearing retirement age. It can provide a guaranteed income stream for the rest of your life, which can help you avoid running out of money after retirement.

People who have Just Starting Earning

Annuities can prove an excellent way for young people to save money. They can protect income and turn it into a corpus with regular payout for later days.

People Who Want their Family to have a Safe Future

Annuities can give your spouse or dependents a guaranteed income in case of your untimely demise.

Aspect Life Insurance Annuities
Primary Purpose Protect against mortality risk (premature death) Manage longevity risk (outliving one’s assets)
Payment Structure Regular premiums paid by policyholder Single or series of premium payments by annuitant
Benefit Payout Lump sum death benefit to beneficiaries Regular income payments to annuitant
Tax Implications Death benefits typically tax-free to beneficiaries Annuity payments may be partially taxable
Cash Value Component Present in permanent life insurance policies Not typically present in fixed or immediate annuities
Common Types Term life, whole life, universal life Fixed annuity, immediate annuity, variable annuity
Example Scenario Pays out a lump sum upon policyholder’s death Provides monthly income upon retirement
Issuers Life insurance companies Life insurance companies and investment companies

How to Buy Annuities?

Buying an annuity involves several steps, and it is crucial to consider the process carefully. Here is a guide on how to purchase annuities:

Evaluate Your Needs

Determine your financial goals, risk tolerance, and how an annuity fits your retirement plan.

Research Types of Annuities

There are various types of annuities, such as variable, fixed, and indexed.

Compare Providers

Research reputable insurance companies or financial institutions that offer annuities. Compare their product offerings, fees, and customer reviews.

Understand Contract Terms

Read and understand the annuity contract thoroughly. Pay attention to payout options, surrender charges, death benefits, and potential penalties for early withdrawals.

Decide on Funding Options

Determine how you will fund the annuity. You can make a lump-sum payment or contribute through regular premium payments.

Purchase the Annuity

Once you have selected the annuity that suits your needs, complete the necessary paperwork and submit the required funds to the insurance company or financial institution.

Benefits of Annuity Plans

Annuity plans are excellent sources of income, along with the flexibility of payout. Explore other benefits of annuity plans below.

Lifetime Source of Income

The fact that an annuity plan offers a consistent income throughout your life, including after retirement, is one of its primary characteristics.

Multiple Options to Choose From

This gives you the freedom to select a plan that meets your needs. You can choose either the joint or single life option to get income for the rest of your life. You can choose to wait a set amount of time and then request your money back. Numerous options are available in annuity plans that let you tailor the plan to your needs.

Tax Benefits

Under Section 80C of the Income Tax Act of 1961, the plan premium you pay at the time of purchase is eligible for a deduction of up to ₹1.5 lakhs.

What is the Best Time to Buy an Annuity Plan?

The best time to buy an annuity plan depends on your financial position and goals. However, here are some factors to consider:

Age and Retirement Timeline

Buying an annuity closer to retirement age or in retirement is more advantageous. You can receive payouts sooner and potentially benefit from higher payout rates.

Interest Rates

Prevailing interest rates often influence annuity rates. If you expect interest rates to rise, you should wait for a higher payout rate. Conversely, locking in a rate sooner might be beneficial if rates are expected to decline.

Market Conditions

If you have investments heavily tied to the market, purchasing an annuity during a market downturn might offer stability and protection against potential losses.

Personal Financial Situation

Consider your overall financial portfolio, risk tolerance, and retirement income needs. Annuities should complement your existing financial plan, so assess whether they align with your long-term goals.

Taxation on Annuity

Annuities can have different tax implications depending on the type of annuity and the country’s tax laws. Generally, annuities can be taxed in two ways: during the accumulation and distribution phases.

Accumulation Phase

During this phase, when you contribute money to an annuity, the growth within the annuity is generally tax-deferred. You will only pay taxes on any earnings or interest once you withdraw funds.

Distribution Phase

When you start receiving payouts from the annuity, your amount will be subject to taxation. The entire withdrawal will be taxed as ordinary income if you have a qualified annuity (funded with pre-tax dollars, like a retirement account). Suppose you have a non-qualified annuity (funded with after-tax). In that case, only the earnings portion of the withdrawal amount will be taxed as ordinary income, while the original contributions will not be taxed again.

It is essential to consult with a tax professional to understand the specific tax implications based on your situation and your type of annuity.

How to Use an Annuity Calculator?

An annuity calculator is a straightforward method that can provide valuable financial planning insights. Here is a step-by-step guide on how to use an annuity calculator:

  • Find an annuity payout calculator online, where you have to fill in the details of your plan.
  • Enter the amount of your starting principal, which is the actual amount you paid to buy the annuity plan.
  • Enter the return rate and number of years you want to get the payout from your annuity plan.
  • Click on the calculate option, and your annual payout amount will be displayed on the screen.
  • Remember that annuity calculators are valuable tools for estimating potential outcomes but are based on assumptions and projections. Actual results may vary due to market fluctuations and other factors.

Conclusion

Annuity plans are like hidden gems in the field of financial planning, offering a unique blend of security and stability. They can be immensely valuable for individuals seeking a steady income stream during retirement or looking to diversify their investment portfolio. So, take the time to explore the various types of annuities, understand the tax implications, and consult with a financial advisor who can help you tailor an annuity plan to match your unique needs and aspirations.

Key Takeaways

  • Annuities are a type of insurance product that provides you with a guaranteed income stream in retirement.
  • Different types of annuities are available; you can choose one that meets your specific needs.
  • Annuities can offer a number of benefits, including lifetime income, tax benefits, and flexibility.
  • It is important to carefully consider your individual circumstances before buying an annuity.
  • You can use an annuity calculator to estimate how much income you will receive from an annuity.

FAQs


1

When can you withdraw money from an annuity?

You can withdraw money from annuity plans at any time, but there may be fees associated with early withdrawals.



2

Is an annuity different from a mutual fund?

Yes, an annuity is different from a mutual fund. A mutual fund is an investment tool that allows you to pool your money with other investors to buy a variety of securities. An annuity is a contract with an insurance company that provides you with a guaranteed income stream.



3

Is there an age limit for annuities?

No, there is no age limit for annuities. However, some annuities may have age restrictions on when you can start taking withdrawals.


4

What is the best age to buy an annuity?

The best age to buy annuity plans depends on your individual circumstances. However, annuities can be a good way to guarantee income in retirement, so it may be a good idea to consider buying one if you are nearing retirement age.


5

Are annuities good for senior citizens?

Annuities can be a good way for senior citizens to guarantee income in retirement. However, it is important to carefully consider the different types of annuities available and the fees associated with each one before making a purchase.

- A Consumer Education Initiative series by Kotak Life

Amit Raje
Written By :
Amit Raje

Amit Raje is an experienced marketer who has worked in various Fintechs and leading Financial companies in India. With focused experience in Digital, Amit has pioneered multiple digital commerce in India. Now, close to two decades later, he is the vice president and head of the D2C business department. He masters the skill of strategic management, also being certified in it from IIMA. He has challenged his challenges and contributed his efforts in this journey of digital transformation.

Amit Raje
Reviewed By :
Prasad Pimple

Prasad Pimple has a decade-long experience in the Life insurance sector and as EVP, Kotak Life heads Digital Business. He is responsible for developing user friendly product journeys, creating consumer awareness and helping consumers in identifying need for life insurance solutions. He has 20+ years of experience in creating and building business verticals across Insurance, Telecom and Banking sectors

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