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Annuity VS Pension

Pension and annuities are two popular and common sources of retirement income. However, despite their similar roles in people’s post retirement financial lives, pensions and annuities are quite different, as they both come with their own sets of pros and cons. Determining which is better and suitable source annuity or pension is a for your retirement and pension income would depend on many factors. Let us first understand the difference between annuity and pension.

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Annuity vs. Pension Plan

Annuity and Pension - Understanding the Key Differences

Annuity vs. Pension Plan
September 03, 2024

Table of Content

 

What is Annuity?

Annuity is among the most popular retirement plans. It is a formal contract signed between you and an insurer, in which you make a lump sum payment to the company and in return, they give you a payout at pre-decided time intervals, or even immediately, as per your financial requirement. An annuity calculator can help you estimate the potential payouts based on your investment, and income stream allowing you to tailor your strategy for a peaceful retirement. Annuity payout options include , immediate, and deferred, which you decide on based on your risk tolerance, financial needs, and goals.

Keep in mind that the primary aim of annuity plans is to provide you a stable and guaranteed post-retirement income. The features of annuity plans can help you understand how different options can cater to your unique circumstances. Overall, it is up to you which option you choose for receiving the payout.

What is Pension?

Pension is a form of post retirement income that is either offered by employers to their employees or can be independently funded in different schemes such as NPS (National Pension System) or through pension plans of one of India's leading insurers, HDFC Life. 

Pension plans offer the twin benefits of investment and insurance post your retirement. By investing a particular amount towards your pension plan regularly, you can accumulate a significant sum that would act as a safety net and steady income inflow for your post retirement life.

Keep in mind that you have two options when cashing out your pension: one is to receive the pension in the form of monthly payments, and the second is to receive the pension in a lumpsum manner. While the first option would provide a regular source of steady income post retirement, the second would grant you access to your entire pension corpus immediately, and it will be upto you regarding how you wish to utilize it.

Types of Annuities and Pensions

When comparing annuity vs pension, it is crucial to understand the different types of annuities and pension plans:

Types of Annuities

1. Immediate Annuity: An immediate annuity refers to the type of annuity in which you make a one-time lump sum premium payment. After that, you start receiving a stream of regular income payments immediately, as soon as within just a month of making the initial investment.

It is also noteworthy that an immediate annuity is suitable for those who prefer putting in a lump sum amount of money, such as their retirement corpus, into a regular income source to meet their day to day financial needs.

2. Deferred Annuity: As its name suggests, a deferred annuity refers to a contract with an insurer, wherein you need to build a corpus initially, which would later be used at the time of your retirement for the purchase of an annuity.

Deferred annuity’s mechanism ensures that you, as a policyholder, receive regular payments in the future, at predetermined dates. This is why it turns out to be a great source of reliable and regular income for the policyholder.

Types of Pension

  • Government Employee Pensions: Central government employees who have retired after serving at least years of service are eligible for pension, provided that the employee retires in accordance with the applicable pension rules.

    With effect from 1st January 2006, a government employee's pension is calculated with reference to either the last basic pay or the average of the basic pay drawn during the last ten months of the qualifying service, whichever is deemed more beneficial. The pension amount shall be 50% of the last basic pay/ average of the last ten months' basic pay. Also, the pension shall be payable up to (and inclusive) the date of demise. You can utilize the online pension calculator tool to compute it.

    In the case of family pensions, the widow receives the family pension upon the death of her spouse, after the completion of either one year of continuous service or before that if the government employee had undergone medical examination by the appropriate authority and was accordingly declared fit for the government service.

  • National Pension System (NPS): NPS (National Pension System) is a market-linked voluntary contribution investment scheme that promotes retirement planning. It was introduced by the central government on 1st January, 2004. Any Indian citizen between 18 years and 70 years is eligible to make an NPS investment. This includes NRIs and overseas Indians as well. However, such citizens should be legally competent to put into effect a contract under the Indian Contract Act of 1872. Also, PIOs (Persons of Indian Origin) and HUFs (Hindu Undivided Families) are not eligible to invest in NPS.

  • Employees' Provident Fund (EPF): The EPF (employee provident fund) scheme allows organized sector employees to receive a pension once they retire after the age of 58 years. However, an employee can claim the scheme’s benefits only if he/she has served for at least years, continuously or not.

    Both the employer as well as the employee need to contribute 12% each of the employee’s pay towards the EPF scheme. But, while the entire share of employee’s contribution goes towards EPF, 8.33% of the employer’s contribution goes towards EPS (Employees’ Pension Scheme, and the remaining 3.67% goes towards EPF contribution per month.

Difference between a Pension and an Annuity

Let us compare annuity and pension on various bases, such as definition, structure, risk, control, ownership, payout, etc.

1. Definition and Structure

Annuity: An annuity is a contract between you and an insurance company, wherein you pay a lump sum amount to the insurer, and they, in return, give you a payout at pre-decided intervals of time or even immediately, as per your financial requirement.

An annuity calculator can help you estimate the potential payouts based on your investment, and income stream allowing you to tailor your strategy for a peaceful retirement. Annuity payout options include , immediate, and deferred, which are decided by you as per your risk tolerance, financial needs and goals.

Pension: Pension is a form of post retirement income that is either offered by employer to their employees, or can be independently funded in different schemes.

By investing a particular amount towards your pension plan regularly, you can accumulate a significant sum that would act as a steady income for your post retirement life.

2. Ownership and Control

Annuity: The owner (annuitant) makes either one or multiple premium payments to the issuer (insurance company) in exchange for future income payments. An annuity can be owned by one individual, held by joint owners

Pension: Pension plans are both established as well as funded by employers to provide retirement benefits to their employees. The employees get benefits based on their salary, years of service, etc.

3. Payout Structure

Annuity: Annuities offer a high degree of flexibility in payouts by allowing options such as immediate, and deferred payout. This is decided by you as per your risk tolerance, financial needs and goals.

Pension: Pensions generally offer a predetermined and regular income post retirement, on the basis of employee’s salary, years of service, etc. You have two options when cashing out your pension. 100% cash out is not allowed, only 60% and balance 40% into annuity. 40% annuity amount can be cashed out provided it offers pension less than 1,000 per month. 

First is to receive the pension in the form of monthly payments, and the second is to receive the pension in a lumpsum manner.

4. Risk and Security

Annuity: You can choose amongst different types of annuities, like immediate, , or deferred, based on your risk tolerance & financial goals. However, the annuity holder also has to factor in the investment risk and manage the annuity plan.

Pension: Pension plans take away the investment risk from employees, as the employer as well as pension fund managers are responsible for all investment decisions. The aim is to ensure the availability of sufficient funds to meet employees’ future pension obligations.

So, employees tend to have lesser control over the fund’s investment decisions and they may receive a fixed amount of pension benefit irrespective of how well the investments go on to perform.

5. Flexibility and Options

Annuity: Annuities offer a high degree of flexibility in payouts by allowing options such, immediate, and deferred payout. This is decided by you as per your risk tolerance, financial needs and goals.

Pension: Pensions generally offer a predetermined and regular income post retirement, on the basis of employee’s salary, years of service, etc. First is to receive the pension in the form of monthly payments, and the second is to receive the pension in a lump sum manner.

Purpose & Benefits of Annuities vs Pensions

Annuities

Annuity's purpose is to provide you with a payout at pre-decided intervals or immediately after you make a lump sum premium payment. The payout provided by annuities acts as an income stream for you post retirement. The benefits of annuities are as follows:

  • Guaranteed Income: Annuities provide a steady stream of income post retirement, which turns out to be helpful in providing financial stability by covering living expenses through the guaranteed payout.

  • Death Benefits: Some types of annuities offer death benefits as well, which provide a financial benefit for your nominees by assuring them guaranteed payments after your demise.

  • Lifetime Income: All annuity plans also offer a lifetime income option, which ensures that you receive payouts for the rest of your remaining lifespan, irrespective of how long you go on to live. This removes the risk of outliving your annuity savings.

  • Multiple Payout Options: Annuities allow multiple payout options, like periodic or lumpsum withdrawals, or even a combination of both of them, thus giving you the flexibility to manage your finances upon retirement.

Pensions

  • Steady Income Stream: Pension plans ensure financial stability by providing a reliable income source throughout your retirement period.

  • Tax Advantages: Pension contributions are often tax-deductible, thereby reducing your current taxable income.

  • Inculcates Financial Discipline: Regular contributions towards your pension account help inculcate the habit of disciplined saving.

  • Market Volatility Protection: Pension plans often guarantee a fixed payout, which shields retirees from market fluctuations’ impact.

  • Gives Peace of Mind: As retirees know that there's a dependable income source for their golden period, they can live with peace of mind as the presence of a pension reduces financial stress

  • Survivor Benefits: Many pension plans offer benefits to survivors by providing a portion of the pension to the spouse or nominees after the primary pension holder's passing.

  • Customization: Different pension plans allow the account holder to do some degree of customization, such as leaving a legacy or providing monetary benefit to the spouse.

Annuity vs Pension - Which Should I Choose?

The choice between an annuity and a pension plan would depend on factors such as your financial goals and risk tolerance.

When comparing annuity and  pension plan, first understand their meaning and purpose. Annuity plans provide you with a stable and guaranteed post-retirement income. They are a contract between you and an insurance company, wherein you pay a lump sum amount to the insurer, and they, in return, give you a payout at pre-decided intervals of time, or even immediately, as per your financial requirements. The payout provided by annuities acts as an income stream for you after retirement. 

On the other hand, pension plans offer the twin benefits of investment and insurance post your retirement. By investing a particular amount in your pension plan regularly, you can accumulate a significant sum that would act as a safety net and steady income inflow for your post retirement life.

When comparing the two, it is important to consider your risk tolerance. While annuities tend to have fewer investment options but at the same time provide you with a safety net by protecting you from market fluctuation, certain pension plans tend to be tied to market performance, thus potentially providing higher returns but also carrying more risk.

Remember that it is important to conduct thorough research about both annuities and pensions before zeroing in on any decision.

Conclusion

The decision to choose between pension vs annuity will require a deep research and adequate understanding on your part. Consider critical factors such as your risk tolerance, financial objectives, retirement requirements, etc. before selecting your investment option for retirement.

You can consider contacting one of India’s largest insurers, HDFC Life, to consult regarding the decision to choose the right retirement plan-annuity or pension.

FAQs on Annuity vs Pension

Q. Is an annuity the same thing as a pension?

No. Annuity and pension are two different sources of retirement income. An annuity gives you a payout at pre-decided intervals of time, or even immediately, in return for a lump sum amount paid to the insurer.

On the other hand, pension is a form of post retirement income that is either offered by employer to their employees, or can be independently funded in different schemes. By investing a particular amount towards your pension plan regularly, you can accumulate a significant sum that would act as a safety net and steady income inflow for your post retirement life.

Q. What is the disadvantage of an annuity?

Some of the disadvantages of annuities include lower liquidity and higher opportunity cost. Firstly, liquidating annuities prematurely is mostly not allowed. And secondly, annuity plans generally offer lower returns than many market linked products, implying that the lower rate of returns of annuities turns out to be the opportunity cost.

Q. What is better than an annuity for retirement?

While there are many other retirement income options such as dividend paying stocks, FDs, bonds, etc, annuities are one of the most common and popular retirement income investment options in India. Annuities’ guaranteed income and multiple payout options are among the biggest benefits that make them a competitive retirement income option.

Q. What is the difference between a pension fund and a retirement annuity?

Pension funds are like financial tools that help you accumulate funds for your post-retirement period. By investing a particular amount regularly into your pension fund, you can gradually build up a significant retirement corpus. A retirement annuity, on the other hand, is a contract between you and an insurance company, wherein you pay a lump sum amount to the insurer, and they, in return, give you a payout at pre-decided intervals of time or even immediately, as per your financial requirement.

Q. How does a pension plan differ from an annuity plan?

Annuity and pension plans are two different sources of retirement income. Pension is a form of post retirement income that is either offered by employer to their employees or can be independently funded in different schemes. By investing a particular amount towards your pension plan regularly, you can accumulate a significant sum that would act as a safety net and steady income inflow for your post retirement life.

On the other hand, annuity gives you a payout at pre-decided intervals of time, or even immediately, in return for a lump sum amount paid to the insurer.

References:

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Francis Rodrigues Francis Rodrigues

Francis Rodrigues has a decade long experience in the insurance sector, and as SVP, E-Commerce and Digital Marketing, HDFC Life, manages the online sales channel, as well as digital and performance marketing. He has had hands-on experience in setting up sales channels and functional teams from scratch over a career spanning 2 decades.

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Vishal Subharwal heads the Strategy, Marketing, E-Commerce, Digital Business & Sustainability initiatives at HDFC Life. He is responsible for crafting and ensuring successful implementation of the overall organisation strategy.

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Annuity and Pension - Understanding the Key Differences

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