What is Annuity - Definition, Working, Benefits, and Types

As per the RBI reports, 50% of Indians above 65 years of age seem to be dependent on their children instead of their own wealth. With rising living costs, increasing medical inflation, and higher life expectancy, individuals must make proper post-retirement plans to curtail their financial burden.

To that end, one of the common modes of financial planning available in India is an annuity plan. If you plan to invest in annuities and know everything starting from the meaning of annuity and benefits, you might consider reading through the following piece.

What Is an Annuity?

Annuity insurance is a long-term investment agreement between a policyholder and the insurance company, wherein the former makes payment in a series of instalments or lump sum. In exchange for this, he or she receives regular disbursements of income post-retirement either immediately or after completing a specific tenure.

These plans offer a host of benefits to unemployed individuals or retired personnel. They might be tailor-made to suit a policyholder's needs.

Further, in case of unfortunate circumstances such as the death of a policyholder, his or her nominee gets to obtain benefits.

Now that you know what an annuity means, let's check out the different types of annuities.

What Are the Different Types of Annuity?

Generally, insurance companies offer six types of annuities. They are as follows -

1. Immediate Annuity

There is no accumulation phase in this type of annuity plan. The plan starts offering benefits right from the beginning of investing. However, a policyholder needs to make a lump-sum investment for this type of plan.

2. Deferred Annuity

Individuals can obtain benefits after the completion of an accumulation period. There are two sections under this plan- the accumulation phase (period during which a policyholder starts investing by making payment on the policy initiation date to start accumulating a retirement fund) and the vesting period (period during which an individual starts receiving benefits).

3. Periodic Annuity

Under this plan, an annuitant receives funds regularly. Furthermore, the companies can also make payments in a phased manner from time to time towards the end of the 5th, 10th and 15th years of investment.

4. Lump-sum Annuity

Some annuities come with an option of a single amount payout. However, one cannot receive the full retirement advantage as a single amount. For instance, in the case of NPS, account holders must mandatorily buy annuities with 40% of the accumulated sum aggregate.

5. Variable Annuity

Under this type, the income generated from the investment depends on the payout stream determined by the performance of the plan's underlying assets.

6. Fixed Annuity

As the name suggests, payouts remain constant during investment tenure under this annuity type. Generally, in these plans, insurance companies put resources into fixed pay instruments. Therefore, one can expect steady returns post-retirement by opting for this plan.

Besides learning about what is meant by an annuity, types of annuity, you must also know how it works?

How Does an Annuity Work?

Here is the working of annuities explained in a step-by-step manner -

Individuals can start investing by making an annuity payment in either lump-sum or instalments.
After this, the insurance provider invests a policyholder's money and provides the latter the returns from this investment on a future date as lump-sum or in annual, quarterly, or monthly instalments.
Several factors determine the income payout, including annuity tenure, among others.
Individuals can choose to receive payments for their entire life or a specific period.
The income generated depends on the type of payout a policyholder chooses - guaranteed payout or a payout stream determined by a plan's underlying investments' performance.

Now, let's focus on the reasons to buy an annuity plan.

What Are the Reasons to Buy an Annuity Plan?

Here are the reasons why one should opt for annuities -

It offers a fixed income after retirement, which helps an individual with daily expenses.
One can expect flexibility in terms of payout by investing in annuities.
Section 80CCC of the Income Tax Act of 1961 offers tax deductions against a lump-sum amount that policyholders pay for an immediate annuity plan.
Some insurance companies offer a free-look period of up to 15 days, wherein the policyholders can go through the terms and conditions of the plans and choose to cancel or withdraw the policy in case of disagreement.
Annuities come with a range of plan options for investors to choose one best suitable for their needs.

In this regard, let's take a look at some benefits of annuities in the following section.

What Are the Benefits of Investing in an Annuity?

Here are some lucrative benefits of investing in annuities -

Annuity insurance plans come with no investment cap, unlike other retirement schemes.
Owing to lower financial costs in India, investors receive inconsistent payouts while reinvesting. However, investing in annuities results in stable payouts throughout the tenure.
One of the major benefits of an annuity plan includes stable and constant returns. No matter how much an individual invests, he or she is eligible to receive cash every month/quarter/half-year/year.

Things to Consider While Buying an Annuity Policy

Before you choose an annuity policy, you must factor in some key parameters that will help you make an informed decision. The factors are -

1. Safety

Considering the safety aspect is paramount in case of these investments as these plans are long-term financial products. In such long-term investments, several factors, such as decreasing interest rates, inflation etc., can affect the returns you receive.

2. Returns

Some insurance companies are conservative in terms of providing payouts. They retain a chunk of earnings as reserves for contingencies. This can be difficult for senior citizens whose daily expenses depend on annuity returns. Therefore, one must consider reading through the terms and conditions before selecting an insurance company.

3. Liquidity

This is another factor that individuals must take into account before choosing a plan. As these products do not generally possess easy liquidity like other financial options, financial contingencies can drive customers towards such an option.

Some of the annuity examples in India include Pension Guaranteed Plan, Immediate Annuity Plan etc.

Now that you know everything about annuity plans in India from the section mentioned above, you can apply for one at your convenience.

Frequently Asked Questions

✓ When can I withdraw money from my annuity?

Under the following conditions, you can withdraw money from your annuity:

If the insured person is diagnosed with a critical illness.
In case of a policyholder's unfortunate demise, insurers pay the original amount or part of it to his or her beneficiary.

✓ What is the best age to buy annuities?

As this plan provides income, retired personnel might find this to be a desirable option. Generally, individuals between 45-55 years of age can consider applying for this plan.

✓ What are the factors to consider while choosing the investment amount for annuity plans?

Before deciding on the amount you wish to invest in annuities, you might want to consider the following factors -

Financial needs, long-term financial goals, savings or investment portfolio, impact of inflation, and other alternative options.