Pension Plan and Annuities
What is Annuity?
An annuity is an investment that you make, either in a single lump sum or through installments paid over a certain number of years, in return for which you receive back a specific sum every year, every half-year or every month, either for life or for a fixed number of years.
After the death of the annuitant, or after the fixed annuity period expires for annuity payments, the invested annuity fund is refunded, perhaps along with a small addition, calculated at that time.
Annuities differ from all the other forms of life insurance discussed so far in one fundamental way - an annuity does not provide any life insurance cover but, instead, offers a guaranteed income either for life or a certain period.
Typically annuities are bought to generate income during one’s retired life, which is why they are also called pension plans. Annuity premiums and payments are fixed with reference to the duration of human life. Annuities are an investment, which can offer an income you cannot outlive and provide a solution to one of the biggest financial insecurities of old age; namely, of outliving one’s income.
How is it beneficial to me?
By buying an annuity or a pension plan the annuitant receives guaranteed income throughout his life. He also receives lump sum benefits for the annuitant’s estate in addition to the payments during the annuitant’s life time.
Also tax benefits are available.
Who should buy this plan?
Annuity income is assured throughout life, but ceases on the death of the annuitant.
An individual who after retiring from service has received a large sum from his Provident Funds, should invest the proceeds in a pension plan or annuity fund available in the market since it is the most satisfactory method of providing a safe and secured income for the rest of his life.
How do I pay for an annuity?
Annuities are paid for:
- Either through a single premium OR
- Through installment payments that are annual in most cases
How do I receive payments from an annuity?
There are several options that are used when the proceeds of an annuity are distributed.
The first is a life annuity, which guarantees you a specified amount of income for your life. On death, the annuity payments cease but your investment is refunded to your estate.
Guaranteed Period annuity (Certain and Life)
A guaranteed minimum annuity, on the other hand, not only provides you with a specified income for your lifetime but, in addition guarantees that your estate will receive payments for a certain minimum number of years, say ten years, even if you should die earlier. On the other hand, should you live longer than ten years, you are entitled to receive annuity payments for you lifetime.
Obviously, any annuity that firmly guarantees benefits to you or your estate can be purchased by paying higher annuity premiums.
Under Annuity 'Certain", the stipulated annuity is paid for a fixed number of years. The annuity payments come to an end at the end of that period, irrespective of how much longer you may live.
However, the selected period remaining annuity installments are paid to the nominees.
The premiums paid into such annuities may be deducted from one’s taxable income at the time of payment. In addition, the interest earned on the annuities is not taxed immediately. This can be quite advantageous, especially to tax payers in higher tax brackets.
Nonetheless, the proceeds of the annuity (which will include accumulated interest) will be taxable when they are paid to you or to your estate as annuity payments.
Deferred annuities eventually result in present tax savings.
When do I receive annuity payments?
Broadly, there are two types of annuities vis-a-vis when you receive annuity payments: an immediate annuity, and the deferred annuity.
In the first case you start receiving annuity payments as soon as you pay the premium, which is usually in a lump sum.
In the case of a deferred annuity, the payments to the annuitant start after a certain deferment period. Typically, the annuitant pays annuity premiums in instalments during the deferment period.
Generally, you will pay less premium for an annuity that provides future payments because the deferment period allows the insurance company to invest your premiums at a profit, thereby reducing the cost of the annuity to you.
How do I evaluate an annuity?
Since annuities are not life insurance policies, we cannot evaluate them as we evaluate other policies. Unlike life insurance policies which cover the risk of the premature death of a family’s breadwinner, annuities should be evaluated just like any other investment option, i.e. on the four-fold criteria of safety, profitability, liquidity and ready availability of your invested capital in case of need, and capital appreciation.
Your capital may be locked up for life. Consider this,
Firstly, during old age there are times when one needs money in a lump sum, whether for hospitalisation, a major surgery, or even for investment in housing, etc. Once locked in these annuity plans, the capital is not available to you should you have any such requirement.
Secondly, these plans also foreclose your option of shifting your investment into newer, more profitable areas, which may emerge from time to time. Even today, alternate investment options yielding higher than 12 percent guaranteed returns are available in mutual funds, company deposits and debentures, etc which also afford the flexibility of retrieving your capital in case of need.
It is strongly advised that you should examine all such options before buying an annuity plan.