An annuity is a contract between an insurance company and a policyholder. Policyholders must make either a lump sum or instalment payments to receive annuity payments after retirement. Furthermore, the annuity can be paid immediately after the lump sum payment or after the completion of the specific period.
Read on as we dig deeper into annuities, its types, workings among other key pointers.
Annuity is an insurance contract in which the insurer (or financial institution) pays the invested money in the form of fixed income in the future. When you sign up for an annuity plan, you enter into a contract with the insurer. You can make a one-time payment or a series of payments through an annuity and eventually receive regular disbursements after a fixed period.
The primary types of annuities are listed below:
A deferred annuity offers annuity benefits once the accumulation period has been completed. Furthermore, you would have to specify a particular age after which you want to start receiving annuity payments from the insurance company.
It offers smaller payments if its investments do poorly and larger future payments if the annuity investment fund does well. Furthermore, the cash flow offered by a variable annuity plan is less stable than that of a fixed annuity. However, it allows you to enjoy the benefits of high returns from your investment funds.
Fixed annuities allow you to receive regular periodic payments. Insurance companies offer fixed annuities in two forms: fixed immediate annuities and fixed deferred annuities. The former provides a fixed rate right now, and the latter pays you later.
Here’s how an annuity works:
An annuity calculator helps you estimate the investment amount for the accumulation phase to receive the desired amount at the end of the tenure. Here are the steps to use an annuity calculator:
An annuity comes with tax deduction benefits. The premium you pay to purchase a plan is allowed as a tax deduction benefit of up to Rs. 1.5 lakh under Section 80C of the Income Tax Act, 1961.
Furthermore, the income you receive from an annuity fund is tax-deferred. It means you have to pay tax at the time of withdrawal and not while you invest in it. The annuity returns are taxed as ordinary income, unlike capital gains in mutual funds. However, you must remember that tax laws are subject to regular amendments.
The annuity contract is structured as follows:
The annuity owner can purchase and fund annuities, withdraw money, change the beneficiary, surrender the contract, pay the premiums, and make any changes before the annuitisation of the insurance contract. Furthermore, the contract owner can be anyone, including an individual, or an entity such as a trust or charity.
The annuitant is insured and must be a person and not an entity. Furthermore, the annuitant can be different from the annuity contract owner; however, both are the same in most cases. The lifetime payments depend on the life expectancy of the annuitant.
The beneficiary refers to the designated recipient of the annuity policy. Moreover, the beneficiary can either be a person or an entity.
Suppose a speculator has invested his profits in an annuity policy. In that case, he may run into trouble if they have a reserve deficit during retirement or need to make a significant, unexpected expenditure.
However, there may be another financial expert who has collected a substantial enough corpus to ensure he is unlikely to encounter a deficiency. An annuity is a wise choice for such speculators due to the reliable instalment stream it provides.
The primary goal of investing in a retirement annuity plan is to create a steady income during your post-retirement years. Thus, the earlier you start investing in an annuity, the more benefits you can receive. Here are two examples that illustrate the importance of early investing:
Thus, the above examples show that the returns are higher when you purchase the annuity plan early.
If you plan on investing in an annuity, here are some points you should consider before finalising your investment decision. These points shall cover both the pros and cons of investing in an annuity:
Also Read: What is Deferred Tax? How is it Calculated?
Annuities are not short-term investment methods but can be tailored for income or long-term gains. People who want long-term financial security, retirement income, diversification, and principle preservation will find these products appealing.
An annuity is a flexible contract offered by an insurance provider that transforms the premiums investors pay into a fixed, guaranteed income stream. Your future annuity payments depend on the type of annuity you choose.
Ans. You can withdraw money for an annuity investment under specific circumstances. Firstly, some annuity plans allow you to withdraw if you have a particular critical illness. Secondly, after the policyholder’s death, several annuities reimburse the nominee in whole or part for the original purchase.
Ans. Although mutual funds and annuities have similar investment mandates and costs, they differ significantly in their investment strategies. Mutual funds can be invested through a SIP or a lump sum payment. On the other hand, an annuity only has one payment method, a lump sum payment.
Ans. Yes, there is an age limit for investing in an annuity. Generally, it varies from one annuity plan to another.
Ans. Yes, it could give financial independence to the individual once he/she has crossed the age of 60 years.
Ans. Yes, annuities can be paid monthly, or even quarterly, annually or lump sum based on investor preference and plan terms and conditions.
This article is solely for educational purposes. Navi doesn't take any responsibility for the information or claims made in the blog.
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