Understanding How Annuities Work
Before we dive into the different types of annuities, let’s look at the basics of how annuities work.
When you buy an annuity, you need to pay a premium. You can pay all of it at once, as a single premium, or spread it over a few years. Premiums help keep your plan active.
When you retire, you receive payouts from the plan. You can choose how and when you want to receive the payouts, as well as for how long you want to receive them. Annuities are also called pension plans or retirement plans.
Tax Advantages of Annuities
Annuities not only provide financial security during retirement but also offer several tax benefits that can help reduce your overall tax burden.
Tax Deduction under Section 80C: Contributions made towards specific annuity plans, such as pension plans offered by life insurance companies and the National Pension System (NPS), qualify for tax deductions of up to ₹1.5 lakh under Section 80C of the Income Tax Act, 1961.
Additional Tax Benefits under Section 80CCD(1B): If you invest in NPS, you can claim an additional deduction of up to ₹50,000 under Section 80CCD(1B), over and above the ₹1.5 lakh limit of Section 80C.
Tax-Deferred Growth: The funds in an annuity accumulate without levied tax during the accumulation phase. Taxes are levied only at the time of withdrawal or annuity payouts, helping policyholders grow their retirement corpus without immediate tax deductions.
Taxation on Annuity Payouts: While the contributions towards annuities can provide tax benefits, the payouts received during retirement are taxable as per the individual’s applicable income tax slab. However, a portion of the maturity amount in certain pension plans may be withdrawn tax-free under specific conditions.
Different Types of Annuities for Retirement
Annuities can be categorised based on when they provide benefits, whether they provide guaranteed or variable income, their life cover benefits, as well as other features.
I. Based on When You Receive the Benefits
Immediate Annuity
In this type of annuity, you receive the benefits immediately after you opt for it. Usually, annuities have a deferment period. It refers to the period between the policy purchase and the start of the benefits. It allows the retirement corpus to grow. However, in an immediate annuity, there is no deferment period. You start receiving payouts soon after you have purchased the pension plan and paid the premiums.
Deferred Annuity
As opposed to immediate annuities, these plans have a deferment period. So, the policyholder will receive the benefits of the plan a few years after they have purchased it. Hence, these types of annuities for retirement are called deferred annuities.
II. Based on the Type of Income You Receive
Variable Annuities
The premiums you pay for this pension plan are invested in market-linked instruments, such as equity mutual funds, stocks, etc. The returns of the investment depend on market performance. Hence, the payouts you receive are variable.
If the funds are performing well, you would receive good returns and vice versa. It is advisable to assess your risk-taking capacity before investing in a variable annuity.
With a retirement calculator, you can enter an estimated rate of return (for instance, 12%) and get an idea of what the returns will be. The tool also asks for other variables like the amount being invested. If you want to assess whether market-linked returns are worth the risk in the long run, this tool can be helpful.
Fixed Annuities
Here, the funds you park in the annuity do not get invested in market-linked securities. Hence, they are not affected by the market’s ups and downs. As a result, you receive a fixed annuity amount that is pre-decided at the time of policy purchase.
Some companies may also offer a fixed indexed annuity, where the corpus grows by a fixed annual interest. But if you choose to, you can opt to receive interest based on positive changes in an external market index. Consult your insurance provider about fixed-indexed annuities before proceeding.
III. Based on How Long You Receive the Benefits
Lifetime Annuity
It is one of the most common types of annuities for retirement. Here, the annuitant (the person for whom the product is purchased) receives regular income for their entire life.
Annuity Payable for a Limited Term
In contrast to a lifetime annuity, this one provides income only for a limited period after retirement. You can choose this period when purchasing the plan. It can be 5 years, 10 years, 15 years, or more. Use an annuity calculator to get accurate estimates when finalising the term.
IV.Based on Life Cover Options
Annuity with Life Coverage
Along with assured income during one’s retirement, an annuity also provides life cover to the annuitant. It gives the annuitant assurance that their loved ones will receive financial support in case of their demise. In some plans, one can also opt for joint life coverage. It means that the policyholder’s spouse also receives the life cover. In case of the spouse’s demise, the beneficiary of the policy will receive the specified amount.
Joint Life Annuity
In these types of annuities, the benefits are extended to the spouse of the policyholder as well. If the policyholder is no more, their spouse continues to receive the regular annuity payouts to help them with their finances. .
Annuity with Return of Purchase Price
It works similar to a regular annuity. However, there is one small difference. In case of an unfortunate event, the nominees chosen by the policyholder will receive the amount paid to purchase the policy. Hence, it is called a return of purchase price annuity.
How to Choose an Annuity?
Selecting the right annuity requires careful planning and consideration of multiple factors. .
Your Financial Goals: Determine whether you need a steady lifetime income, market-linked returns, or an annuity with life cover. Identifying your retirement needs will help narrow down suitable options.
Payout Preferences: Choose between immediate or deferred annuities based on when you want to start receiving payouts. If you need an income source soon after retirement, an immediate annuity is ideal. For long-term wealth accumulation, a deferred annuity works better.
Risk Appetite: If you prefer stable, predictable returns, a fixed annuity is a good option. If you can tolerate market fluctuations, a variable annuity may provide higher growth potential.
Life Cover Benefits: If ensuring financial security for your loved ones is a priority, opt for an annuity plan that includes life coverage or a joint life annuity for spouse protection.
Tax Efficiency: Consider plans offering tax benefits under Sections 80C and 80CCD(1B). Ensure that the tax treatment of annuity payouts aligns with your tax planning strategy.
Flexibility & Liquidity:Some annuities offer partial withdrawals or surrender options, while others do not allow early withdrawals. Assess whether you need liquidity features before committing to a plan.
Comparison & Provider Reputation: Compare plans from different insurers, check annuity rates, and evaluate the insurer’s track record in terms of financial stability and claim settlement ratio.
Important Things to Note about Annuities
The different types of annuities mentioned above are not exclusive to each other. For instance, you can opt for an immediate annuity plan with joint life coverage. It can also come with the return of purchase price feature. However, some types of annuities may not allow certain features. Consult your insurance provider for more details.
The annuity payouts you will receive during retirement are taxable as per prevailing income tax laws. However, you can claim a tax deduction of up to ₹1.5 lakhs under Section 80C of the Income Tax Act, 1961, against your annuity contributions.
Payments made towards specific pension plans like the National Pension System come with additional tax benefits under the same section. You can consult a tax expert for personalised guidance. **
Are Annuities Right for You?
Annuities are beneficial for retirees looking for a stable and guaranteed income, but they may not be suitable for everyone.
Annuities are suitable if you:
Require a predictable income stream after retirement.
Have limited risk tolerance and prefer financial security.
Want to ensure that your spouse continues to receive income after your passing.
Are looking for tax-deferred investment growth during the accumulation phase.
Annuities may not be ideal if you:
Need high liquidity or flexibility in accessing your funds before retirement.
Prefer investing in higher-yielding market-linked instruments with full control over withdrawals.
Have alternate sources of retirement income and do not need an annuity’s structured payouts.
Annuities are a reliable financial tool for ensuring a stable income stream during retirement. They come in different types, including immediate, deferred, fixed, variable, single and joint life, allowing retirees to choose on the basis of their needs. As a result, an annuity plan is a great option to support you and your loved ones during your retirement.
Annuities offer tax benefits under Sections 80C and 80CCD(1B), making them an attractive option for tax-efficient retirement planning. However, evaluating personal financial goals, payout preferences, and liquidity needs is essential before purchasing an annuity. By selecting the right annuity plan, retirees can enjoy financial stability and peace of mind in their golden years.
An annuity ensures that you have a steady source of income regardless of the status of your income from other sources and employment avenues. Consider factors such as your goals, your payout needs, your budget, and so on, to choose the right type of annuity. To make your planning easier, ensure to use a retirement calculator. With the right annuity plan, you can steer your retirement in the right direction – one filled with peace and financial freedom.
FAQ
Basics of Annuities
What is the difference between an annuity and a pension plan?
An annuity is a financial product providing periodic income, typically after retirement. A pension plan, on the other hand, is a broader term that includes different retirement savings options, including annuities.
How do I know which annuity is right for me?
Consider factors such as your financial goals, risk appetite, required payout frequency, and tax benefits. Consulting a financial advisor can also help you make an informed decision.
Can I buy an annuity without life insurance coverage?
Yes, you can choose an annuity without life coverage if your primary goal is to receive guaranteed retirement income rather than securing life insurance benefits for your beneficiaries.
What happens to my annuity if I pass away?
If your annuity has life coverage, your beneficiaries will receive a sum assured. In joint life annuities, the spouse continues to receive payouts. Annuities with a return of purchase price option ensure that the initial investment is refunded to the nominee.
Investing in Annuities
Is an annuity a good investment?
Annuities provide financial security and stable income, making them a good investment for those seeking predictable retirement earnings. However, they may not offer high returns when compared to market-linked investments.
Are annuities taxable in India?
Yes, annuity payouts received during retirement are subject to income tax as per your applicable tax slab. However, contributions made towards certain annuities qualify for tax deductions under Sections 80C and 80CCD(1B).
Can I withdraw money from an annuity before retirement?
Some annuity plans allow early withdrawals under specific conditions, but most have restrictions. Premature withdrawals may also attract surrender charges and tax implications.
** Tax exemptions are as per applicable tax laws from time to time.
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