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Types of Annuities

Annuities are among the most popular options for achieving financial security after retirement. Sold by insurance companies, annuities provide a fixed payout in instalments, often for the rest of the insured person’s life allowing them to fulfil their post-retirement dreams.

There are a variety of annuity plans available in the market that is suitable for the different needs of investors. While some types of annuities offer fixed payouts, others have variable payouts, making it important for investors to learn about their differences. Learn about annuity and types of annuity plans below.

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Types of Annuities

Understanding Types of Annuities

Types of Annuities
November 11, 2024

Table of Content

 

What Are Annuities?

An annuity is a type of financial instrument offered by insurance companies. It is a long-term financial contract where the insured person invests their money either through a lump sum or in instalments. In return, the insurer agrees to give a fixed payout for a predetermined period, which can be the rest of a policyholder’s life. 

The primary aim of an annuity plan is to provide a stable and reliable income after your retirement. Unlike traditional life insurance plans, whose main purpose is to protect your loved ones from your untimely demise, annuity plans protect your financial well-being from the risk of living too long and depleting your savings. In short, they provide a buffer over your retirement savings.

Annuities can take a variety of forms. While some types of annuities provide a substantial lump sum at maturity, others provide a fixed payout at intervals (e.g., every month). The former option is ideal for achieving financial goals that require a large amount of cash, while the latter provides a fixed and dependable income. 

Annuity plans can also be immediate, where payouts begin right after payment or deferred, where payments begin after a predetermined maturity period. Annuities can also be structured to make payments for a fixed period (e.g., 10, 20 or 30 years) or the rest of your life. The payments can also be predefined or variable.

What Are the Different Types of Annuities in India?

As mentioned before, there are many different types of annuity plans where you can invest depending on your needs. Here are the most popular annuity types in India:

1. Immediate Annuity

An immediate annuity plan provides a guaranteed stream of income as soon as the policyholder makes the lump sum payment. These are typically single premium plans and can start making payouts within one month of the initial investment. These plans are ideal if you are nearing retirement and don’t have enough savings for the future. 

These annuity plans provide a safe and reliable means of income immediately after retirement. You can choose to receive payouts on a monthly, quarterly, half-yearly or yearly basis as per your needs. Some annuity plans offer customisation options, such as money-back facilities and adding your spouse to the plan. The payouts can be fixed, inflation-adjusted or variable as per market performance.

2. Deferred Annuity

With this type of annuity plan, you invest a sum of money over a certain period, and the insurer provides you with regular payments at a later predetermined date. Deferred annuities have an accumulation period, which allows your invested funds to grow in value, allowing for better returns compared to immediate annuities. 

Deferred annuity plans are ideal if you don’t require supplementary income immediately. This allows the annuity to build more potential earnings from the accrual of interest and capital gains. Depending on the type of deferred annuity, you can get guaranteed but low returns or higher potential returns but with some risks. 

3. Fixed Annuity

A fixed annuity promises a specific payment at a future date. The insured person makes a lump sum or period payments, and in return, the insurer agrees to pay a fixed amount for a defined period or the rest of a policyholder's life. These plans are the most suitable for risk-averse investors like retirees looking for safe and assured income. 

To deliver the fixed payout, the insurer invests the entire premium in low-risk financial instruments such as Treasury Bills and highly-rated corporate bonds. Fixed annuities can provide fixed interest income or inflation-adjusted income, making them a good fit for investors who don't want to take any risks.

4. Variable Annuity

In a variable annuity plan, your lump sum or instalments are invested in market-linked assets such as stocks or mutual funds. As a result, their returns can rise or fall in value with the market performance of the assets. While the returns are unpredictable, variable annuities can provide higher potential returns over time. 

Variable annuities are ideal for experienced investors familiar with the risks of various asset classes. They are preferred by investors who are looking to generate higher profits compared to traditional annuities while taking on higher risks. Like other annuity plans, variable annuities offer the flexibility to choose immediate or deferred payments as well as different maturity periods.

How Do Different Types of Annuities Work?

As mentioned before, all annuities are financial contracts between insurers and individuals. The insured person makes a lump sum payment or a series of payments to the insurer. In return, the insurer invests the funds and provides fixed or variable returns over a defined period. 

Learn how different types of annuities work below:

1. Life Annuity:

This type of annuity plan provides assured and regular payouts as per predetermined terms for the rest of a policyholder’s life. These payouts stop only when the insured period is no longer alive. These plans provide a stable source of income after retirement and are ideal for risk-averse investors.

2. Joint Life Annuity:

Also called joint and survivor annuity, this type of annuity allows you to add your spouse to the plan. These plans pay a fixed income for the rest of your life or your spouse’s life in the event of your demise. While it covers both spouses for the rest of their lives.

3. Life Annuity with Refund of Purchase Price:

These types of annuities provide payouts for life. In the event of the insured person’s death, these plans provide a payout equal to the initially paid purchase price to the nominee.

4. Annuity Paid for a Fixed Term:

These plans allow you to select a predetermined period, like 10 years, 20 years and 30 years, over which you will receive payouts. A shorter tenure allows you to get higher monthly payments but increases the risk of depleting your retirement savings. These plans are ideal only when you need supplementary income for the early years of your retirement.

Advantages and Disadvantages of Different Types of Annuities

Advantages:

  • Annuities provide a reliable source of income, often covering the entirety of your life after retirement.
  • Most annuities invest in low-risk assets, which allow them to provide guaranteed returns safe from the ups and downs of the market.
  • Some types of annuities are designed to offset the effects of inflation, and they provide a steady income that increases year after year.
  • Insurance companies allow a range of customisable options for annuities. You can vary the tenure of payments, choose immediate or deferred plans, add your spouse to the plan or include death benefits through riders.
  • Some annuities offer professional money management services, allowing you to increase your returns.    

Disadvantages:

  • As an investment vehicle, annuities typically offer lower returns than direct investments such as stocks and mutual funds.
  • Liquidating an annuity in the middle of the tenure is not possible in most cases.
  • As insurance companies have to bear certain expenses for managing annuity plans, they come with higher fees compared to traditional investments.

Tax Advantages of Annuities

The income received from an annuity plan can be taxed under the head 'Income from salaries' if the plan is a part of your employment package. The income received from such a pension is taxed at a part of your taxable income under standard tax slab rates. This income is eligible for a standard deduction of up to Rs. 50,000 if opted for Old tax regime or Rs. 75,000 if opted for New tax regime for FY2024-25.

However, for pension plans that you have purchased separately, the income is taxed under the head ‘income from other sources’. At a standard tax Slab rate applicable to the individual. This income is not eligible for the standard deduction.

Annuity plans are also eligible for various benefits that lower your tax liabilities in case of Old tax regime. These are:

  • Deductions Under Section 80C: You can avail deductions of up to Rs. 1.5 lakh on investing in certain investments like NPS, NSC, EPF, Life Insurance Plans, etc.
  • Section 80CCC: It allows deductions on contributions to certain pension & annuity plans of life insurance companies
  • Section 80CCD (1): This allows additional deductions on specific pension plans.

Deductions can be claimed under 80C, 80CCC and 80CCD (1) of Income Tax Act, 19611 but the total deductions cannot exceed Rs 1.5 lakh a year for all the investments put together. 

Here are the income tax stabs for senior citizens and super senior citizens for FY 2024-25 under the old tax regime. If you receive the benefits of an annuity plan after retirement, these rates will apply:

Income Tax Slab (Yearly Taxable)

Senior Citizen Tax Rate (60 - 80 years)

Super Senior Citizens (For More Than 80 years of age)

From 0 to Rs. 3,00,000

Nil

Nil

From Rs. 3,00,000 to Rs. 5,00,000

5%

Nil

From Rs. 5,00,000 to Rs. 10,00,000

20%

20%

Rs. 10,00,000 and above

30%

30%

How to Choose an Annuity?

When choosing an annuity plan, you must look at compare its benefits against price to understand whether it suits your financial needs. First, check its effective rate of return by checking the guaranteed sum against the premium price. Next, you should try to understand the future value of your investment by adjusting for the rate of inflation. 

You will also need to know the various charges applicable to your annuity plan. Different types of annuities also come with different payout and liquidity options. Choose the right type of annuity plan based on your financial situation and retirement needs. There are two more important factors you must check when you choose an annuity:

  • How Long Payments Last: When choosing an annuity plan, you need to decide how long its payment duration should last. A shorter duration plan allows you to opt for larger monthly payments. However, such a plan may be over while you are still alive and in need of funds.
  • Protection for Your Spouse: If you are married, it may be a good idea to opt for a type of annuity plan that can cover your spouse. This will provide him or her with sufficient financial protection in your absence, covering the rest of his or her life. If either of you don't have sufficient retirement savings, this could be an ideal facility.

Are Annuities Right for You?

Annuities provide you with assured income for the rest of your life after retirement. They are perfect solutions for anyone looking to supplement their post-retirement income or pay entirely for their post-retirement lives. These are suitable for risk-averse individuals who want a simple and fixed source of funding. 

However, annuities are not the best standalone investment due to their relatively low liquidity and high fees. They are meant for people who cannot actively manage their portfolios. Instead, they work well as a guarantee for financial support in your advanced age as you are no longer able to make active investment decisions. This ensures you can live a comfortable life after retirement.

Summary

Annuities are a flexible, low-risk and reliable investment for your post-retirement years. Having an annuity plan ensures that you can live your golden years comfortably and achieve your long-term goals without having to depend on others. There are many types of annuities, each with its own payout options, tenures and premium options. Select the right option depending on your financial needs and risk appetite.

FAQs on Types of Annuities

What is annuity and its classification?

An annuity is a financial instrument where one party (the insurer) agrees to pay the other (the insured person) a fixed sum of money over a fixed time. It provides additional income to the insured person after his or her retirement. There are four major types of annuities, namely immediate annuities, deferred annuities, fixed annuities, and variable annuities. 

What is the best type of annuity plan?

The best type of annuity plan depends on your financial needs and risk appetite. If you don't want to take any risk, fixed annuity plans with lifetime coverage may be the best option. Deferred annuity plans suit those who have some time to build their investments for the future. On the other hand, if you are nearing retirement age, you will want to pick an immediate annuity plan. 

How does an annuity plan work?

Annuity plans are contracts between two parties- 1) an insurance company and 2) an insured person. The insured person pays a certain sum (as a lump sum or in instalments), while the insurance provider agrees to pay a certain income (typically after the insured person's retirement). Annuities have two phases: 1) an accumulation phase, where policyholders pay premiums, and 2) a distribution phase, where they receive benefits from the plan. 

When is the right time to buy an annuity?

The best time to start investing in an annuity plan is as soon as you are eligible to purchase one. Typically, this is around 40 to 45 years when you can start investing in an annuity plan. The earlier you start, the more time your annuity plan has to provide better income. 

How are annuities taxed?

Private annuity plans are taxed under the head 'income from other sources'. On the other hand, income from government pension schemes is taxed under the head 'salaries' and is eligible for various income tax benefits.  

How much do I need to invest in an annuity?

There is no exact amount you need to invest in an annuity plan. The amount you should invest will depend on multiple factors, such as your existing retirement savings, assets, fixed expenses and obligations like mortgages. Many experts recommend allocating around 5% to 10% of your retirement savings to annuities.   

RELATED ARTICLES

References

https://www.investopedia.com/articles/retirement/08/annuity-mutualfund.asp

https://www.etmoney.com/learn/nps/annuity-and-nps-everything-to-know/

https://www.investopedia.com/ask/answers/093015/what-are-main-kinds-annuities.asp

https://www.policybazaar.com/life-insurance/pension-plans/articles/deferred-annuity/

https://www.investopedia.com/terms/v/variableannuity.asp

https://www.livemint.com/money/personal-finance/income-tax-rules-for-annuity-received-from-lic-11602983162327.html

https://tax2win.in/guide/annuity-taxation-how-are-annuity-payments-taxed

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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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1. Tax benefits & exemptions are subject to conditions of the Income Tax Act, 1961 and its provisions. Tax Laws are subject to change from time to time.

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