Different Types of Annuities

An annuity is a financial tool that can allow you to access a stable stream of income either immediately or after a pre-determined period of time. To avail the benefits of an annuity plan, you need to invest either a lump sum amount or make regular premium payments to the annuity provider over a pre-determined time period. In return, the insurer commits to paying you a guaranteed income at regular intervals—monthly, quarterly, semi-annually, or annually.

There are generally two stages in the lifecycle of any type of annuity plan:

1. Accumulation Phase – The period when you invest money i.e. make the regular payments or one-time lump-sum payment to the annuity provider.

2. Payout Phase – The period during which the insurer makes regular pay outs to you.

Annuities can be an ideal source of regular income for individuals such as senior citizens who may not have access to a stable income or have limited pension income after retirement. One of the key reasons for the popularity of annuity-based pension plans is the fact that these policies offer predictable income and are relatively low risk instruments to plan retirement finances.

Below are the various types of annuities that are currently available in India and can cater to various financial needs of individuals seeking regular post-retirement income:

• 1. Immediate Annuity

As the name suggests, immediate annuity plans provide you with payouts soon after (usually within 1 month) you make a lump sum investment in the plan. It is an ideal choice for someone who is nearing retirement or has already reached retirement age and wants to start receiving regular income from annuities without any delay.

It is important to note that in the case of this type of annuity plan, the key benefit is that it offers instant cash flow. Moreover, you can customise the payout frequencies - monthly, quarterly, half-yearly, or yearly. Some plans also allow you to extend the payout benefit to your spouse and or other dependents. This way they can continue to receive the annuity income even after your death.

• 2. Deferred Annuity

Deferred annuity is a type of annuity plan that offers a more future-oriented retirement solution. Deferred annuity plans allow you to make either lump sum investments or periodic payments into the scheme, as per your choice. The annuity payout starts after a pre-determined period of time, called the deferment period, has passed.

A key advantage is the accumulation period offered by a deferred annuity. During the accumulation period, you can keep making relatively small investments and grow your retirement corpus at either a fixed interest rate or as per market performance. Subsequently, at the end of the accumulation period, the investment undergoes superannuation and the corpus created is used to purchase annuities. These plans are best suited for people who are still working and are saving for their retirement that is decades away.

• 3. Fixed Annuity

Fixed annuities provide assured returns, independent of the market dynamics. When you invest in a fixed annuity, the annuity provider (typically a life insurance company) promises to pay a specific amount at regular intervals for a specific time period (such as 10 years, 20 years, etc.) or your entire lifetime. This type of annuity plan is often preferred by conservative investors who prioritise investment safety and certainty of payout over the potential of high returns.

Another type of annuity plan is currently available globally but has not been introduced in India so far – variable annuity plans. In this case, the payout can be potentially higher than fixed annuity plans, however, these annuity plans invest in market-linked instrument hence, they can be significantly riskier as the payout amount is not guaranteed.

How an annuity works differs to some extent depending on the type of annuity plan you have chosen to invest in. Below are details of how various types of annuities work:

• Step 1: Start by deciding the type of annuity you want, i.e. immediate or deferred. Then, buy it from an annuity provider such as a life insurance company.
• Step 2: Once you choose the plan, make the payment. In the case of an immediate annuity plan, you will need to make a single lump sum payment. On the other hand, in the case of a deferred annuity plan, you can make regular relatively smaller payments over time. These investments earn interest over time, which helps grow the retirement corpus.
• Step 4: Throughout your retirement, you will receive a steady income, giving you peace of mind and financial stability. In the case of some annuity plans, annuity payouts may be paid out to the spouse/dependent after the demise of the primary annuitant. This way annuities are a great way to ensure you don't run out of money during your retirement years.

Annuities come with their unique benefits and limitations. Here's a detailed breakdown:

Advantages

• The key benefit of annuities is that they offer a guaranteed income, which in turn ensures peace of mind and financial independence post-retirement.
• The next major benefit is that annuities are fixed-return instruments that are not impacted by market ups and downs.
• Some annuity plans offer annual increasing payouts linked to inflation, helping you keep up with rising costs.
• Joint plans and refund options allow you to customise base annuity plans so that they can provide extended financial protection for your dependents.
• After making the annuity investment, there’s minimal effort required to manage the investment, ensuring peace of mind.

Limitations

Below are key limitations of different types of annuity plans:

• Annuities offer limited liquidity as withdrawals are restricted.
• Annuities offer fixed returns that may be lower than other asset classes such as equities.
• Fixed income may not be sufficient if inflation rises significantly.
• Annuity payouts are taxable as per your income tax slab.

Annuities can be an excellent solution for individuals seeking consistent and guaranteed income during retirement. They take the guesswork out of managing finances in your golden years. However, they may not be suitable if you want high returns or quick access to your funds.

Many people begin by asking, "what is annuity?" Simply put, it’s a financial product that provides regular payouts that can be used as a reliable income source after retirement.

Overall, annuities provide mental peace and financial stability. Choosing the right retirement-focused investment depends on your retirement vision, financial goals, and the kind of life you want to live after you stop working. With the right type of annuity plan in place, you can retire worry-free and focus on enjoying every moment of your second innings.