What are annuity plans and how do they work

Annuity or pension plans can be bought at any time in your life. Some people choose to buy it when they are close to their retirement age, while some people prefer it during their mid-career who wish to secure their assets. In insurance, some products help you accumulate a corpus with which you can buy an annuity later, but if you have a ready corpus, you can buy annuity immediately. These are called deferred and immediate annuities, respectively.

Also Read | How India has become an unequal republic

Under an annuity plan, you pay a lump sum in the accumulation period and get regular payments as long as you live or for a pre-specified fixed period. “Annuity plans are specifically designed to meet the long-term retirement needs of people with a decent corpus for investment. An annuity plan allows you to lock-in the existing interest rate not just a for a period of 10/15/20/25 years but your entire life,” said Vivek Jain, Head Investments, Policybazaar.com.

Types of annuity plan

Deferred annuity plans: These plans essentially help people to save for the future where they let you invest regularly to first build a corpus and once you retire you get a pension from this amount.

For instance, the National Pension System (NPS) and pension plans offered by insurers come in this annuity type as they first help you build a retirement corpus and then annuities a part of that corpus.

Also Read: NPS is low-cost but it has some limitations as a retirement tool

Coming to insurance, “It requires customers to pay a premium which plans can be systematic or one lump sum premium. When the tenure period ends, the accumulated money is used to buy an annuity, although in deferred annuity plans, only 1/3rd of the corpus can be withdrawn tax-free and the remaining 2/3rd will be having to be taken as compulsory annuity turning into steady monthly income. It is always advisable to invest in your early stage so that one has enough corpus for the future. The longer you leave your investment, the better it will grow,” said Jain.

For instance, a person is 35 years old and is planning to have a financially secure future for his later years and today, if he pays ₹6,000 as monthly premium for 15 years, the fund value he will get will be around ₹17,00,000 at the return rate of 8%.

Immediate annuity plans: This type of plans is for people who want to invest at a later stage of life. With an immediate annuity, you hand over a lump sum cash to the insurer and in exchange, the company starts making your monthly payment like an income stream. If you are nearing your retirement stage and have a corpus ready, then you can buy an annuity plan immediately. They differ from deferred annuities as they do not have an accumulation period.

Jain said, “Annuities can be either fixed or variable depending on whether the payout is a fixed sum, tied to the performance of the overall market or group of investments, or a combination of the two.”

How do annuities work?

• First, you need to make a lump sum investment in the annuity plan.
• The annuity will provide you with payments on a future date/s. This can be provided on a monthly, quarterly, or annually basis.
• The annuity or pension payout is determined by several factors, including the tenure of the annuity.
• You can opt to get the pension payments for the rest of your life or a fixed period.
• The annuity or pension income also depends on whether you have opted for a fixed annuity that is a guaranteed pay-out or variable annuity, that is, a pay-out stream determined by the performance of the annuity's underlying investments.

Taxation

Annuity products are specifically designed to meet long-term retirement needs. An annuity plan offered by insurance companies give you periodic cash flow and primarily serve as an income source for retired people.

When you buy a pension plan from any insurer, at the accumulation phase, that is when the policyholder pays the premiums, no other tax is levied apart from Good and Services Tax (GST). At the vesting stage, when the corpus is paid for commutation of pension, it is exempt from tax. However, when these payments get annuitised, taxes can get imposed based on the applicable Income-tax rules.