What is an annuity plan? All you need to know

Many people near retirement age are looking to secure a reliable source of income post-retirement. And many people blindly buy the annuity plans that their insurance agents suggest. But is this the right approach? We don’t think so.

It is because we need to be aware of different nuances before investing in any investment option. This is the start of an eight-part series on annuities. We hope that by the end of it, you will become confident about annuities.

What is an annuity plan?

An annuity is a financial product created and backed by an insurance company offering guaranteed monthly payments for the contract duration. It is essentially a contract offered by an insurance provider that transforms money paid by customers into a stream of guaranteed fixed income.

This contract takes care of your longevity risk, i.e., the likelihood that you will outlive your savings. This risk is transferred to the insurance provider by paying the premium lump sum or at regular intervals.

An annuity may be tailored depending on several factors, including your life expectancy, the start date of your payments, and whether you wish to transfer your income stream to a beneficiary after your passing.

Typically, in India, most people buy annuity plans to fund their retirement income.

Features of annuity plans

Here are some of the features of annuity plans:

Guaranteed income: After retirement, annuity products provide a guaranteed income. This fixed sum guarantees a consistent flow of money in accordance with your original contributions. Hence, you never run out of money while you are retired.

No cap on maximum investment: There is no maximum investment limit in the case of annuities, unlike other retirement plans with a cap on the maximum investment amount.

Deferment period: You may put off receiving your regular income for some time, and within that time, you can continue to build up the fund, which will help to increase your annuity’s value. In this period, you withdraw a lump sum amount as well.

Types of annuity plans

Broadly, annuity plans can be classified into immediate and deferred annuity plans.

Immediate Annuity: In an immediate annuity, the interval between the accumulation and disbursal phases is remarkably short. The accumulation phase of an annuity policy is the time when you pay premiums. The annuity payments are given to the policyholder during the disbursal phase. According to the terms of the annuity policy, payouts are handed out immediately in the case of an immediate annuity.

Deferred Annuity:  In a deferred annuity, there is a delayed period between the accumulation phase and the point at which the policyholder receives annuitized payments. Payouts in a deferred annuity scheme begin at a future date because of a lengthier accumulation phase.

How do annuity plans work?

• You must first invest a lump sum in the annuity plan.
• You will get payments from the annuity at a later date on a monthly, quarterly, or annual basis. You can decide that.
• The length of the annuity is one of many variables that affect the payout of the annuity or pension.
• You can receive pension benefits for the rest of your life or a specific period.
• The annuity or pension income is also based on your choice of a fixed annuity, which is a guaranteed payout, or a variable annuity, which has a payout stream that is based on how well the underlying investments perform.
• In addition to the fixed or variable payout, the current interest rate, the deposited amount, age, gender and the length of time for receiving income also impact the annuity income.

Things to keep in mind before buying annuity plans

• In comparison to other products, the annual returns on annuities have not been very appealing. Other products, such as Senior Citizens Savings Scheme and five-year Fixed Deposits, might offer higher returns than annuity plans.
• Premature withdrawals are not permitted from annuities. An annuity might not be the best option if you need access to your principal amount.
• Annuity plans use simple interest instead of compound interest. Most investment options use compound interest instead of simple interest.
• The minimum age to buy an annuity plan depends on the life insurance company. Some companies have a minimum investment of 30 years, while others have a minimum age limit of 40 years.

Conclusion

In conclusion, annuities can be a great investment option for those looking for financial security in their retirement. These plans offer regular income for those who want to secure a comfortable future. However, it is important to understand the terms and conditions of these plans before investing and to seek professional advice if necessary.

Padmaja Choudhury is a freelance financial content writer. With around six years of total experience, mutual funds and personal finance are her focus areas.