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Annuity Meaning

An annuity is a long-term investment agreement between an insurance company and an individual in which the individual makes payments in series or in a lump sum, in exchange for which he gets periodic disbursements or income, either immediately or in the future.

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Annuity Meaning

What is Annuity?

Annuity - Meaning, Benefits and Types
September 03, 2024

Table of Content

 

What is Annuity?

Annuity is among the most popular retirement planning ways. It is a formal contract signed between you and an insurer, in which you make either a lump sum payment or regular smaller payments to the insurance company and in return, the insurer gives you a payout at pre-decided time intervals, or even immediately, according to your financial requirements.

Keep in mind that the primary aim of annuities is to provide you a stable and guaranteed post retirement income. After retirement, the payout from annuities serves as an income stream for you. Annuity payout options include fixed, variable, immediate, and deferred, which you decide on based on your risk tolerance, financial needs, and goals.

How Do Annuities Work?

Annuities are a retirement income plan aimed to provide you with a steady cash inflow during your retirement years. Simply put, an annuity is a formal contract signed between you and an insurer in which you make a lump sum payment to the company and, in return, the insurer gives you a payout at pre-decided time intervals or even immediately, according to your financial requirements.

Using a retirement calculator can help you determine the optimal amount to invest in an annuity to ensure that your post-retirement cash flow meets your needs. Annuities often prove to be an appropriate retirement income planning tool for those who want a stable and guaranteed cash inflow post-retirement.

Features of Annuity

  • Fixed vs. variable returns

Annuities offer a high degree of flexibility by allowing payout options such as fixed, variable, immediate, and deferred payout. The payout option is decided by you as per your risk tolerance, financial needs and goals.

  • Tax advantages

No tax is required to be paid on the earnings from annuity investment until you make withdrawals or begin getting periodic payouts. However, the withdrawals done before the age of 59½ years might be subject to an additional 10% income tax.

Also, the contributions/premiums made towards the annuity plan qualify for tax deductions under Section 80C, 80CCD and 80CCC1, with a limit of up to Rs 1.5 lakh in a financial year.

  • Lifetime income options

Some annuity plans 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 greatly helps by removing the risk of outliving your annuity savings.

Different Types of Annuities

1. Immediate annuities

An immediate annuity plan refers to the type of annuity wherein 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.

This type of annuity can be 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. Additionally, keep in mind that the payout structure in immediate annuity can either be fixed or variable, depending on your choice.

2. Deferred annuities

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.

This type of annuity 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. Moreover, the money you invest into a deferred annuity has the potential to grow through the accrual of interest or the investment returns before the annuity payments get started.  

3. Fixed Annuities

As its name suggests, a fixed annuity plan involves a fixed amount of payout throughout the time period of the plan’s tenure. Fixed annuity provides a stable and assured payout throughout the entire tenure of the plan, but only after the lump sum premium is paid. It is also considered the most suitable annuity plan for risk averse investors who are seeking a constant payout throughout the term.

Also, keep in mind that the payout is done at a fixed rate of interest on the investment and does not change for the predetermined tenure.

4. Variable Annuities

Variable annuity involves a lump sum investment, in return on which you get a variable return. Simply put, a variable annuity directs your lump sum premium payments towards investment options that may include different types of funds, such as mutual funds, whose returns are linked to the performance of the underlying securities. This is what makes variable annuity a suitable investment option for those who are willing to take risks and are aiming for higher returns, too.

Who Buys Annuities?

Once you understand annuity meaning, you would wonder, who buys annuities, right? Well, those who wish to have a stable as well as guaranteed retirement income should consider buying annuities. The primary aim of an annuity plan is to make sure that you get financial freedom post your retirement and enjoy that golden period without any financial worry. You can use the annuity payout for many purposes, from covering your daily expenses like medicines and groceries to big post retirement goals like a foreign vacation.

Also annuities also remove the risk of you outliving your retirement income stream, which thus hedges the longevity risk.

What Are Tax Implications Of Annuities?

The payout you receive from annuities is considered a 'monthly salary' for tax treatment, which is why it is taxed as per your applicable income tax slab1 and gets included under the 'income from all other sources' head.

Now, let us take an example to help you understand the taxation on annuities. Suppose you are aged 62 and are receiving a monthly annuity of Rs 41,000 post retirement, and have opted for the new tax regime (for FY 2023-24). Assuming that you do not have any other income sources except the annuity income, your annual income turns out to be Rs 4.92 lakhs (Rs 41,000*12). So, as per your tax slab of Rs 3-6 lakh (FY 2023-24), you would be taxed 5% of your income after claiming the standard deduction of Rs 50,000. So, your tax for that year with annuity income would be Rs (4.92 lakh-Rs 50,000) *5%= Rs 4.42 lakh *5%=Rs 22,100.

Benefits of Annuity plans

The benefits of annuity plans 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.
  • Lifetime Income: Some 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.
  • Creditor Protection: In certain scenarios, annuities can also offer protection from creditors, thus helping you safeguard your assets from potential financial risks.
  • 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.
  • Tax-Deferred Growth: Earnings from your annuity are tax-deferred until you start making withdrawals. This allows your investment to rise faster when compared to investments whose earnings keep getting taxed.
  • Multiple Payout Options: Annuities allow multiple payout options, like periodic or lump-sum withdrawals, or even a combination of both of them, thus giving you the flexibility to manage your finances upon retirement.
  • No Contribution Limits: Annuities typically involve no contribution limits, thus allowing you to invest bigger sums, to secure your post-retirement income.

Example of an annuity

A simple example of an annuity can be in the form of NPS (National Pension System). An annuity in NPS refers to a regular income that you receive after the retirement age of 60. Given that it is mandatory to buy an annuity as a component of NPS, this ensures a steady and guaranteed income for you after retirement. As per PFRDA's rules, a minimum of 40% of your total accumulated NPS corpus has to be compulsorily used towards the purchase of an annuity. The remaining 60% of the NPS corpus is free to be withdrawn tax-free and in a lump sum.

Conclusion

If you wish to have a stable and guaranteed income post retirement, check of HDFC life Pension Guaranteed Plan, or you can consider exploring HDFC Life Annuity Plans.

Once you buy the right annuity plan after factoring in your retirement age, risk appetite, and financial goals, annuities can prove to be a great retirement planning tool through the dependable income stream.

Keep in mind that the primary aim of annuities is to make sure that you get financial freedom post your retirement, and enjoy that golden period without any financial worry. You can use the annuity payout for many purposes, from covering your daily expenses to big post retirement goals.

FAQs on What is Annuity

Q. How does an annuity plan work?

Annuities are a retirement income plan aimed to provide you with a steady income during your retirement years. Annuity meaning is in the form of a formal contract; annuities first need you to make either a lump sum payment or regular smaller payments to the insurance company, and, in return, the insurer gives you a payout (whether as a lump sum or pension) at pre-decided time intervals, or even immediately, according to your financial requirements.

Q. When should I buy an annuity?

As per financial experts, it is usually suggested to buy an annuity between the age of 50- to 70 years. However, it is wise to factor in your financial goals, risk appetite, and planned retirement age and then make the decision to buy annuities accordingly. You can take suggestions from experts when planning to purchase annuity plans from one of India's leading insurers, HDFC Life.

Q. What is the rate of return in an annuity?

The rate of return on annuity plans differs depending on the chosen annuity plan for investment. The returns on annuities can usually range between 5%-8% per annum.

Q. How much do I need to invest in annuity?

There is no exact limit on the amount that you have to invest in annuities. Factor in your financial goals, investment horizon, current and expected assets and liabilities, risk appetite, retirement age, etc. and then accordingly arrive at the amount you need to invest in annuity plans.

Q. What is annuity in simple words?

In simple words, an annuity is a formal contract signed between you and an insurer in which you make either a lump sum payment or regular smaller payments to the company and in return, the insurer gives you a payout at pre-decided time intervals or even immediately. 

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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 Vishal Subharwal

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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1. Tax benefits are subject to conditions under Sections 80C, 80D, Section 10(10D) and other provisions of the Income Tax Act, 1961.

2. Provided all due premiums have been paid and the policy is in force.

HDFC Life Pension Guaranteed Plan (UIN:101N118V11) is a single premium non-linked, non-participating annuity plan.

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