Purchasing an annuity can provide financial security in retirement, but they are not without risks. It is important to carefully review the features and fees of any annuity before making a decision.
Are you considering investing in an annuity for your retirement income planning? Before making any financial decisions, it’s crucial to examine the benefits and drawbacks of an annuity plan, which can guarantee a stream of income for a certain length of time.
We are back with the second article of the annuity series on the pros and cons of annuities. Let us take a closer look. You can click here to read the first part.
Pros of annuity plans
Here are some of the crucial pros of buying an annuity plan:
Gives a sense of safety
The most significant benefit of annuities that attracts soon-to-be-retired individuals is the sense of safety that the annuity plans to offer its customers. You can be sure that you will keep getting money every month for the rest of your life if you buy an annuity.
You can pick how often you want to get your fixed payouts, i.e. monthly, quarterly, half-yearly, or yearly. So, you don’t have to care about how much money you can redeem every month without running your retirement kitty dry.
Removes the market risk and interest rate risk
Annuity plans are free from market risk and interest rate risk. This means that the annuity you will receive does not depend on the current market scenario. Also, when we look at other traditional retirement products, such as Post Office Monthly Income Schemes (POMIS), Fixed Deposits (FDs) and Senior Citizen Savings Schemes, we can see that these solutions are prone to the risk of reinvestment.
That means that if the interest rate of the overall economy is trending lower, then the interest rate on these options will also come down. So, when you go to reinvest your money, you might receive a lower interest rate on your principal. But annuity plans don’t carry this risk. In most cases, the annuity income fixed at the beginning of the disbursal period will continue for the rest of your retired years.
Most annuity plans benefit from tax exemption under the relevant Sections 80C and 10(10D) of the Income Tax Act. Section 80C provides tax deduction up to a maximum of ₹.1.5 lakhs for the premium paid against the policy. In addition, under Section 10(10D), any income you get from your life insurance policy is free from income tax. Bonuses and surrender values are included in the deductions, and there is no upper limit to these deductions.
Safety of principal
The fact that the value of a fixed annuity is guaranteed to be equal to or greater than the invested amount is one of its salient characteristics. The insurance company can ensure you will get your money back from the annuity investment.
Cons of annuity plans
We have seen the various advantages of annuity plans. Now, let us look at some of the cons of annuity plans.
Lower returns than other investment products
The returns from annuity plans may appear to be relatively lower when compared to other market-linked products. But, most customers see it as a trade-off for regular income and peace of mind. Also, because of the low returns, annuity plans fail to keep up with inflation.
An annuity plan doesn’t allow premature withdrawal of money. This is primarily due to the fact that annuity plans are managed like retirement funds, which make investments with long investment horizons in mind. However, certain plans might permit early capital withdrawals but might be cumbersome.
A significant criticism of annuity plans is their high-cost management fees and sales commissions. In addition, certain annuity plans have extremely high minimum investment costs.
Annuities can be a useful tool for retirement income planning, but investors should consider all aspects before investing. While annuities offer the benefits of guaranteed income and tax advantages, they also have potential drawbacks, such as high fees, early withdrawal issues, and limited investment flexibility.
It is crucial to consult with a financial professional who can help you understand the various types of annuities and their features to make an informed choice that aligns with your financial goals and needs. They can assist in determining whether an annuity is a suitable investment for your specific financial situation and provide guidance on selecting the most appropriate type of annuity.
Remember, investing in an annuity is a long-term commitment that requires careful consideration. Taking the time to assess the pros and cons and consulting with a financial advisor can help ensure you make an informed decision that is best for you and your retirement plans.
Padmaja Choudhury is a freelance financial content writer. With around six years of total experience, mutual funds and personal finance are her focus areas.