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A guide to understanding annuities

  May 13,2023

Are Annuity Plans Right for You? A Guide to Understanding Annuities

Annuities are an attractive option for retirees seeking a reliable source of income. However, before making any decisions, it is important to understand what annuities are and how they work.

Annuity plans, also known as annuities, are periodic payments or payouts made to policyholders from the accumulated corpus. These are a kind of regular income to provide financial assistance during old age.

With money accumulated from policyholders either in installments or lump sums, annuities allow you to plan for retirement needs in advance.

Whether your other assets are depleted, or you don't have a ready source of income to survive post-retirement years, annuity plans come to the rescue. Withdrawals from such plans can only be made only after certain periods.

So, it is an agreement between investors and insurance companies wherein investors pay premiums in exchange for regular payments after the policy ends.

How do annuity plans work?

The working of annuity plans is simple. Let's understand how they work in brief.

  1. For annuity plans to work, you are required to invest money either in installments or lump sum to build a corpus towards the annuity plan.
  2. The annuity will ensure that you consistently get a certain income on a future date. The payment/income can be monthly, quarterly, half-yearly, or yearly, depending on the type of annuity plan.
  3. Your pension or income depends on several factors, such as the policy's tenure, policy type, corpus accumulated, etc.
  4. It is your wish if you wish to get annuity payments for a fixed period i.e. 15 years, 20 years, etc., or for a lifetime.
  5. The period in which you make payments towards the policy is known as the accumulation phase. Here, on a tax-deferred basis, the amount you invest towards an annuity grows.
  6. And once your payments or income begins, it is known as the annuitization phase.
  7. Income will depend on whether you choose a fixed annuity plan or a variable plan.

 

Types of annuities

 

Based on several factors, annuities are categorized into different types. Let's have a look at them and their structure.

  • Immediate annuity plans: Such plans have no accumulation phase, meaning the premium is paid in a single go. You will start receiving the guaranteed income almost immediately. It is best suited for people on the verge of retirement and needing immediate income.
  • Deferred annuity: In this plan, there is a long gap between the accumulation and annuitization phases. Since there is a huge gap, payouts usually start at a future date.
  • Fixed annuity plans: Such plans are best suited for individuals who have low-risk tolerance but still want decent returns. These plans guarantee buyers to pay a fixed rate of return on the money they invest for specific periods. The guaranteed sum of money post-retirement is ensured.
  • Variable annuity: It is quite the opposite of the previous one. Variable annuity plans do not ensure to payment of a fixed sum of money to investors. A certain amount is paid to you based on your preferred investment's performance. In this, you have a choice to select your preferred investment option among others.
  • Lump-sum annuity plans: You'll see most annuity plans pay a certain sum of money at regular intervals. However, a few of the plans offer you a lump sum amount on maturity. But you must note that you can avail of this benefit only after a specific time.

 

Tax Benefits and Implications on Annuity in India

Contributions made during the accumulation stage of a delayed annuity plan are eligible for tax deductions under Section 80CCC, up to a maximum of Rs 1.5 lakh per fiscal year. Section 10(10A) allows for the tax-free withdrawal of up to one-third of the corpus at the moment of vesting.

The remaining amount is paid out as an annuity as the annuity is a form of income, which is treated as income and taxed accordingly.
 

This blog is purely for educational purposes and not to be treated as personal advice. Mutual funds are subject to market risks, read all scheme-related documents carefully.

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