Annuities are a means to offer stable and fixed income until death. It is useful for everyone after retirement. People fund these annuities in advance through regular payments, buying a scheme or such. Old age is unpredictable and being financially secure is a need to ensure that you don’t have to face troubles in your hour of need. During such time, annuity comes to the rescue by providing returns on a monthly basis. If you also want to get an annuity, here’s everything that you should know about what is annuity, how they function, types and benefits of annuity!
What is Annuity?
Annuities are contracts that pay out a set sum of money over a designated period. To know what is annuity, one needs to understand why they are essential. Also known as an income replacement for the rest of one’s life or for a set amount of time. After retirement, in the absence of a steady income, one may have to rely on their savings or assets to support their financial obligations.
Often these assets may not be sufficient to maintain their monetary requirements, which is why some investors may choose to purchase an annuity contract from an insurance company or other financial institutions.
Therefore, the answer to what is annuity is that it is an income replacement investment solution that gives people a consistent cash flow during their retirement years and mitigate concerns about exhausting their assets and savings.
After knowing what is annuity, one must know the phases that follow once you avail an annuity policy and the different types of annuity that you can choose from as per your requirements. Now that you are aware of what is annuity, let’s discuss how they work.
How Do Annuities Work?
Since a wide range of annuity plans are available in the market. You must understand how they work before you reach any decision. These different plans have different ways of working-
- Life annuity policy- Under this plan, you will get regular payments until death.
- Life annuity policy with the return of purchase- In this annuity policy, you will receive regular payments throughout your life. However, the pending amount will be given to the nominee in case of your demise.
- Guaranteed annuity policy- here, you will get a regular income for a fixed period. In case of your demise, the nominee will receive the payment. Once the time is over, the payments will stop.
- Joint annuity plan- In this plan, you will get the benefits throughout your or your spouse’s lifetime.
- Joint annuity policywith return of purchase- The payments are similar to the joint annuity in this plan. However, in case of your or your wife’s demise, the pending amount will be given to the nominee as per the plan.
Why Choose an Annuity plan?
Making the right choice when it comes to investment plans and annuity insurance is vital to a secure future. This is why having an annuity policy is thus best suited for people who want to supplement their retirement income or turn a huge lump amount into a consistent stream of cash flows over time. These features make it a reliable investment. On more exploration of annuity benefits, one may come across the NPS and ask what is annuity in NPS which is a retirement scheme devoted to the aid of retirees after they leave the workforce.
Phases of an Annuity Policy
- Accumulation Phase: The accumulation phase is the time between when an annuity policy commences and when payouts start. This is the time for the financial corpus to grow gradually for later use. During this period, any money put in the annuity grows tax-deferred.
- Annuitization Phase: Once the accumulation phase for the annuity policy elapses and the gradual payments start coming in, that is called the annuitization phase.
Benefits of Purchasing an Annuity Policy
An annuity policy offers a steady stream of income after retirement. Here are the numerous benefits of signing up for an annuity policy to solidify your finances after retirement.
- No matter how much fund you save and plan to use upon retirement, old age will throw unexpected financial troubles at you. It’s best if you had a solid plan; this is where an annuity plan can help you.
- An annuity policy is a safe investment tool that offers a steady income stream to you, your spouse and later the nominee in case of your demise as per the plan.
- The amount you pay as a premium for the annuity policy is deductible under the tax saving under Section 80C.
- Annuity policy offers higher liquidy, so you need not worry that your money is stuck.
Is An Annuity a Good Investment?
Having an annuity policy is similar to having insurance. In some annuities, you can opt for bonds, stock and such investment choices. An annuity policy is designed to offer a hedge for a longer time period. Having an annuity policy is a good investment if you are meeting your financial goals with the plan you are opting for.
Types of Annuity Plan Payouts
Now that the basics of what is annuity have been established, we can take a closer look at the types of annuity policy a prospective investor can choose from for their post-retirement needs. Annuity insurance by its very nature is designed to be customisable as per the needs of the customer. Various factors are taken into consideration when choosing between the following types of annuity policy:
Immediate Annuity
An immediate annuity policy provides a fixed income for a fixed period. Once you deposit your money, you start receiving the payment as well.
Deferred Annuity
A deferred annuity starts paying out later, which is decided upon by the insured. Deferred income annuities do not pay out until after the original investment is made. Instead, the client chooses an age when they want to start receiving payments from the insurance provider.
Fixed Annuity
Fixed annuities provide a set amount of money each year. These annuity policies, which pay a fixed rate right now, and fixed deferred annuities, which pay you later, are two types of this annuity. A low annual return is one of the predictable drawbacks of a type of annuity, which is often slightly greater than a bank’s certificate of deposit.
Variable Annuity
As per the name, variable annuities offer the possibility of a bigger return, but they also come with a higher risk. As with most market-linked assets and investment plans, you can choose from a menu of mutual funds that go into your personal “sub-account”. The retirement payouts you thus receive are determined by the performance of the investments in your sub-account.
Also Read: Calculating Annuity: Here’s How You Do It
Pros and Cons of Annuity
To understand what is annuity or what is annuity in NPS, it is also necessary to know what are the pros and cons of annuity policy-
Pros
- Guaranteed income replacement payouts for life
- Customisable as per the investor’s financial requirements
- It may come with probate and creditor protection
Cons
- Comes with high surrender/sale charges
- Less liquidity due to the long lock-in periods
- Payouts may be taxable
Annuity Surrender Period
Now that you know about what is annuity, you should know that most investment instruments like an annuity policy have a minimum lock-in period that needs to elapse before the investor can make any withdrawals for their financial requirements. The surrender period is the amount of time that an investor must wait before withdrawing cash from an annuity without incurring a penalty.
Knowing what is annuity is not where the discussion for stable retirement funds ends. Withdrawals made before the surrender period’s completion may be subject to a surrender charge, which is a deferred sales fee. This time period usually lasts several years. If an investor withdraws the invested amount before the surrender time expires, they may have to pay a high surrender charge. This measure is in place to discourage recurrent transactions from the annuity fund so that the money stays secure for retirement.
Also Read: Guaranteed Annuity Rate
Conclusion
The question of what is annuity and its features can often be intimidating to navigate for new retirees, which is why having access to a thorough breakdown of all its features always helps. Post-retirement relief is something that everyone must have access to, which is why you should actively start looking for annuity plans to keep you comfortable and secure well after your days of retirement has begun.
FAQs
An annuity is an income replacement investment solution that is designed to give people a consistent cash flow during their retirement years and mitigate concerns about exhausting their assets and savings.
Same as the operations of a regular annuity, an annuity in NPS is a retirement scheme that is covered under the National Pension Scheme and is regulated by the PFRDA. It operates as a voluntary retirement plan and has a mandated 60-year lock-in period.
An immediate annuity is one that begins paying out to the insured right away, whereas a deferred annuity is one that begins paying out at a later date which is decided upon by the insured.
A variable annuity is a market-linked retirement scheme where you can choose from a menu of mutual funds that go into your personal “sub-account”. The retirement payouts you thus receive are determined by the performance of the investments in your sub-account. Variable annuities offer the possibility for a bigger return, but they also come with a higher risk.
The surrender period is the amount of time that an investor must wait before withdrawing cash from an annuity without incurring a penalty. Withdrawals made before the surrender period’s completion may be subject to a surrender charge, which is a deferred sales fee.
You can opt out of an annuity policy anytime you want. However, please remember that you will only be taking out a portion from the full annuity policy.
The age limit varies as per the type of annuities. If you are buying a fixed index annuity policy, you can buy it till you are 90-years old. Apart from this, the minimum age for buying an annuity policy is 30, whereas the maximum age is 100-years old.
The answer depends on the type of annuity policy you have. If you have an annuity for life, the payment will cease upon your death, whereas when it comes to annuity policy for life with return of purchase, the pending amount will be sent to the nominee. In a guaranteed annuity policy, the payment will be sent out till the fixed time to the nominee.
While buying an annuity policy, check the policy guidelines to know whether the payment will stop or continue.
70 to 75 is considered as the best time to start retirement annuity pay out as it maximises the returns. However, only you can decide when the annuity policy should start paying out.
Some annuity plans last till the time you are alive while some end upon your demise. Check your annuity policy to know which one does your policy follow.
You can buy an annuity policy at a bank in India.
Read more about Deferred Annuity.
