Types of Annuities | Understanding the Different Categories

Post-retirement financial planning is very important as after retirement, you will have limited sources of income. There are different types of annuities that will help you during your golden years. The different types of annuities have various benefits which allow you to deal with inflation and lead a retired life without compromising your standard of living.

What Is an Annuity?

An annuity is a long-term investment agreement between an individual and an insurance company. For this, you need to pay in series or lump sum. In exchange, you will get a regular payment after your retirement for the rest of your golden years.

Annuities serve the purpose of providing you with a regular stream of income when you are retired and do not earn any money. You can customise your annuities to suit your needs. While investing in annuities, you can choose the form of an annuity and how you want to receive your payments. There are mainly two forms of annuities, deferred and immediate. 

In case of an untimely demise, the nominee you select will get the annuity benefits. You can even withdraw from an annuity under specific conditions.

How Do Annuities Work?

Now that you are aware of what an annuity is, here is how an annuity works:

• To receive an annuity, you need to invest either via a lump sum or instalments in the annuity plan.
• You will receive the benefits on future dates or a series of dates. You will receive the payment monthly, quarterly, annually or through a lump sum payment.
• There are various factors, such as the annuity tenure on which your payout is determined.
• You can opt to receive the annuity in the form of monthly payments for the rest of your life or for a specific tenure.
• Your annuity amount will depend on whether you have opted for a fixed annuity or one which depends on the performance in the market.

Who Buys Annuities?

It is a great idea to buy annuities young to get value leverage. You also get enough leeway to change your course if you get some negative impact from your investment. Considering the taxation and interest rates, you might want to buy annuities in small amounts. 

Annuity plans are comparatively easier to buy than life insurance as no medical examinations are required. In addition, the lack of liquidity options of annuities helps keep the retirement corpus intact.

What Are the Different Types of Annuities?

There are different types of annuities for retirement. Here are some of the key types of annuities that are offered in India:

1. Immediate Annuity

There is no accumulation phase in this type of annuity. These plans start offering benefits right from the time you start investing. You need to invest in lumpsum so that the annuity payout begins immediately. You can get an annuity for your entire lifetime or a limited tenure. This plan is suitable for people who are retired or will retire soon. 

There is also an option of a joint-life pension annuity plan under which annuity payments continue for your spouse’s lifetime.

2. Deferred Annuity

This scheme lets you accumulate a corpus through a single or regular premium payment over a policy term. Therefore this scheme is suitable for all types of investors, whether they prefer to invest systematically or in a chunk. After the accumulation phase is over, you will start getting payouts. 

There are two phases in deferred annuity plans, they are:

• Accumulation phase: This is the period when the policyholder starts investing in the plan in the form of premium payment. This premium is invested in the type of plan that you select.
• Vesting phase: This is the phase when your policy reaches its maturity, and you start receiving the benefits of your plan. In this phase, you can either withdraw the proceeds and invest in another scheme or start receiving benefits from your plan.

3. Fixed Annuity

In this type of deferred annuity plan, you get an annuity payout that is constant throughout the payment period. This plan invests mainly in fixed-income instruments and is a relative conservation option. 

Therefore, there is potentially little growth of the principal amount you have invested during the accumulation phase of your plan. However, this fund might be preferred by many risk-averse investors as it provides a guaranteed income to them after retirement.

4. Variable Annuity

This type of deferred annuity offers varieties of annuity payouts during the payments. The insurance company invests the initial corpus into a portfolio of mutual funds that the buyer chooses. These types of payouts depend on the market performance of the funds you have invested your money into. If the fund you invested in performs well, you will get high returns and vice versa. 

As its returns tend to fluctuate, this type of plan is suitable for investors with a high-risk appetite. However, it cannot give assured results. This might make it unsafe for risk-averse investors or retired people. One example of variable annuities is NPS, which has a link with the market and does not guarantee a fixed payout, unlike the other government schemes.

5. Indexed Annuity

In the case of this plan, the annuity payout increases by 2% to 5% every year to incorporate inflation. So, though it might not have a link with the actual inflation rate, it helps deal with the increase in expenses to some extent.

6. Lump Sum Annuity

While some annuity plans offer periodic payments after a stipulated period, this plan provides the payout in a lump sum. However, it must be noted that the lump sum payout is an alternative and is accessible only after a stipulated period. 

A number of conditions stated by the insurance company also apply to this type of plan. It may also happen that the full retirement benefit is not possible as a lump sum.

7. Periodic Annuity

This type of annuity provides payouts at regular intervals. It might be in a monthly manner similar to pension payments. You can also receive the payouts at regular intervals, such as at the end of 5, 10 or 15 years. This is irrespective of whether all premiums have been paid or not. 

8. Certain Annuity

In this type of annuity, the annuitant gets the premium for a specific number of years. People will get to choose the period for which they wish to receive the payment. The nominee will get the annuity if the annuitant dies before receiving the whole amount.

9. Life annuity

Under this plan, you will receive the annuity until death. If you choose the option “with the spouse,” your spouse will get the pension amount after your death.

10. Guaranteed period annuity

In this type of plan, you will receive an annuity for certain periods like 5 years, 10 years, 15 years, or 20 years whether the insured survives or not. 

Tax Implication of Annuities

Annuities can be good investment avenues that provide a regular stream of money to dependents. Annuities as such do not have any tax liabilities until withdrawals or payouts are made.

The premium payment is tax-free if you invest in a deferred annuity. This means you can grow your income in the accumulation phase without paying any tax. During the accumulation phase, your premium payment qualifies for tax benefits under Section 80CCC which offers deductions of up to Rs. 1.5 lakh in a financial year.

During the vesting phase, one-third of the corpus can be withdrawn tax-free under section 10(10A). The remaining is treated as income and is taxed accordingly. As your post-retirement income will be low, tax liability will also be reduced significantly.

Final Word

Retirement planning is one of the essential parts of your financial planning. Your professional life will come to an end one day or the other. From that time, you will be dependent on your savings and investments. Therefore, choosing from the different types of annuities available in the market is an important task. Planning judiciously will help you spend your golden years peacefully. 

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