It is a kind of contract between Insurance Company and you in which you either make lump sum payment or regular payments in order to receive regular income that would begin either on the immediate basis or after a certain time period.
• The prime objective of annuity is to provide regular income to you during your retirement
• It gives you an option to choose the following:
o Type of investment that whether it would be lump sum or regular payments
o You can also choose whether you want to annuitize it immediately or want it to be paid after a certain time period
o Also you have an option to choose whether you want to receive the payment for a fixed time period or for lifetime
• But, choosing for life time payment option will lead to providing you payment of lower amount as compared to payment for fixed duration
HOW ANNUITIES WORK?
It is an investment product popular for retirement planning. It is provided by Life insurance Companies and is popularly sold by insurance agents.
It keeps on accumulating interest without making you to pay taxed till 59.5 years of age. And at this stage the principal and the interest earned is paid back in form of regular payments as per the term chosen (5 years, 10 years or lifetime)
WHAT ARE THE TYPES OF ANNUITY?
• Fixed Annuity
As the name suggests it guarantees a fixed amount that is paid considering the balance of your amount. But, the interest rate is lower as compared to others because the investments are not linked with market based products
• Variable Annuity
Interest rate is high and so is the risk involved. In this kind of annuity you have to choose from a list of mutual funds that would be considered your personal “subaccount”. Therefore, the retirement payment is entirely based on the performance of your sub account.
• Indexed Annuity
It is considered as a mid-way out of the other two types of annuity options. The interest rate is slightly higher than the fixed annuity but lower than the variable annuity. You will receive a minimum guaranteed pay out but a part of your investment is linked with the performance of market.
HOW DIFFERENT TYPES OF ANNUITIES BEHAVE DURING RECESSION & GOOD ECONOMIC TIMES?
As discussed above different kind of annuities have different behaviour in different situations:
FIXED ANNUITY INDEXED ANNUITY VARIABLE ANNUITY
RETURNS EARNED DURING RECESSION
Comparatively Lowest Moderate Risk Highest Risk involved
LINKED WITH MARKET BASED PRODUCTS
No Link A part of investment is linked with market Entirely market based
RETURNS DURING GOOD ECONOMIC TIMES
Returns earned is guaranteed but you may feel that it has
Underperformed as compared to other two options as A part of returns is fixed and rest is linked with market thus it leads to better performance as compared to Fixed Annuity Investor is rewarded by aggressively better returns for bearing high risk
WHAT ARE THE REASONS DUE TO WHICH PEOPLE AVOID TAKING THE OPTION OF VARIABLE AND INDEXED ANNUITIES?
• These options are quite complex in nature
• Buying fee of these annuities is high
• Surrender charges need to be paid if you are willing to withdraw the money during the first few years of making contract
WHAT ARE THE ADVANTAGES OF ANNUITY?
• Regular Income Guaranteed
It helps you in guaranteeing a regular source of income during retirement.
• Account for Inflation
There are annuity options available in market that considers the inflation part which means the value of money increases as per the inflation. This helps you plan in a better way for your retirement
• Tax Benefit
It is tax deferred which means you do not have to pay the tax at the time of earning that capital rather you pay at the end. Thus, it helps you to accumulate cash in the beginning and earn interest without paying tax also the money keeps on compounding
WHAT ARE THE DISADVANTAGES OF ANNUITY?
• Irreversible Decision
It is a one-time decision that cannot be reversed thus making right choice is of high importance. Once you have signed the contract and have started receiving income it is not possible to change the provider unlike other saving options.
• Hidden fee
Most of the annuity plans we come across sounds quite fascinating and profitable but one should read the fine print carefully to know about the hidden fee clause as it can cut down your profits earned
• Surrender Charges
In Most of the annuity plans if the investor wants to withdraw the money during the early years of making the payment then they will have to bear the surrender charges. The surrender charges slightly differ for different companies
• No support to the Family
In case a person invests the entire pension amount in annuity then after your death the left over money will belong to annuity provider and not the deceased’ family.
WHAT ARE THE FACTORS ON WHICH TYPES OF ANNUITY PLANS DEPENDS?
It broadly depends on below mentioned two factors:
• Targeted Retirement Income
• Whether you want that your spouse should receive annuity after your death
WHAT ARE DIFFERENT KINDS OF ANNUITY PLANS AVAILABLE IN MARKET?
• Plans that provide fixed annuity at the interval chosen throughout the life time
• Plans that provide annuity for a fixed duration, in this plan high annuity amount is paid for the fixed period. And after the fixed duration is over less amount of annuity will be paid until the death
• Return of Premium annuity plan- Fixed annuity is provided until death and after the death nominee receives the premium paid either lump sum or in parts. Though fixed annuity amount is quite low in this plan
• Increasing rate Annuity- This plan is considered ideal to people who consider the inflation part and believe that the cost of living increases with time.Annuity amount keeps on increasing yearly as per the plan.
• Joint annuity- This is a kind of plan taken by the buyer and his spouse. In this plan buyer gets pension amount throughout his life and after his death the spouse receives same amount until the death
ANNUITY PLAN TAX BENEFITS
The annuity payment made up to INR 150000 can get deducted from your taxable income. Although the income received through annuity is entirely taxable.
Example: In case your taxable income is ₹ 800,000 and annuity premium paid by you is of ₹ 100,000 every year, than the taxable income will be ₹ 700,000. However, if you start receiving annuity of ₹ 50,000 every month on retirement, this amount will be fully taxable.