What is Annuity

09 July 2024
5 min read
What is Annuity
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An annuity is a contract you buy from financial institutions. When you purchase this plan, the company promises to pay you a steady income, either immediately or at a later date.

You can invest in an annuity by making monthly payments or a one-time lump-sum payment. People mostly use annuities to secure income for retirement, helping to ensure they do not run out of money as they age.

To learn more about the workings of an annuity policy, its types, and more, read on. 

How Do Annuity Plans Work in India?

To understand what an annuity is and how it works, read the following:  

Step 1: Choose the type of annuity you want to buy. Then, buy the plan via a bank, broker, or insurance company.

Step 2: Make the payment. The insurance company then invests this amount, allowing your account to earn interest over the contract period.

Step 3: When you decide to start receiving your payments from the annuity, these payments will be a combination of your original investment amount and the accrued interest, excluding any applicable fees.

Step 4: Throughout your retirement period, you will receive the regular income from the annuity.

Different Types of Annuities

Now that you know the annuity meaning, let's explore its types. These are the types of annuities in India:

1) Deferred Annuity 

In a deferred annuity, there is usually a long wait period between the time you start investing and the time you begin receiving payments. It is often used for post-retirement income. Deferred annuities come in two forms. These are as follows:

  • Fixed Annuity 

A fixed annuity gives you a steady income. When you buy this annuity, you know exactly how much money you will receive, and this amount will not change. It is not affected by market ups and downs, ensuring a stable income throughout the period.

  • Variable Annuity 

A variable annuity’s payouts depend on market performance. This type of annuity has two phases: the accumulation phase and the vesting phase.

During the accumulation phase, you invest money in the annuity. In the vesting phase, you start receiving payments, which can vary based on how well the annuity performs in the market.

2) Immediate Annuity Plans

In an immediate annuity, the gap between the accumulation phase and the disbursal phase is very short. It involves paying a lump sum premium instead of multiple payments.

With an immediate annuity, these payments start right away, according to the terms of your policy. It is ideal for individuals nearing retirement who want to start receiving monthly income right away.

3) Lump-sum Annuity

In India, most annuities provide regular payouts after a set period, but they can also offer a lump-sum payout. Keep in mind that this lump-sum option is only available at specific times.

Additionally, you might not be able to take the entire retirement benefit as a lump sum.

Benefits of Annuities

After understanding annuity definition, let’s have a look at its advantages. The following are the benefits of an annuity insurance plan: 

  • Annuity plans provide guaranteed returns and are low-risk investments, ensuring your wealth grows over time and protects you from the ill effects of inflation.
  • Your accumulated funds from annuity planning not only cover your essential needs but also protect against unexpected expenses that could impact your savings.
  • Some annuity plans offer coverage for 40 critical illnesses, providing additional financial security during health emergencies.
  • By having a well-planned annuity, you can avoid dependence on loans and credit, ensuring your daily expenses and major life goals are covered without worry.
  • At the end of the income period, certain annuity plans offer a return of premium, providing additional financial security.
  • In the event of your death during the policy term, your annuity plan includes life insurance coverage to support your loved ones.
  • With regular income from your annuity, you can focus on achieving both short-term and long-term financial goals for yourself and your family.
  • Annuity plans offer tax deductions under Section 80C of the Income Tax Act, helping you save on taxes while securing your future income.

Eligibility Criteria for Annuity Plans in India

Annuity plans are slowly gaining acceptance among people as a choice for retirement savings in India, providing a steady income after you retire. Here are the common eligibility criteria:

  • Age

You can invest in an annuity plan if you are between 30 and 85 years of age. The exact age limits can vary depending on the specific plan you choose.

  • KYC (Know Your Customer)

Completing the KYC process is mandatory. This involves providing identity and address proofs along with other necessary documents.

  • Source of Income

You need to have a regular income, such as a salary, business income, or pension, to invest in annuity plans.

  • Nationality

Both Indian citizens and NRIs can invest in annuities. However, the rules for NRIs may vary based on the country in which they reside.

  • Health Status

Sometimes, annuity plans might need a medical examination to assess your health. It is generally needed for plans with longer payment periods or offering higher payouts.

Tax Implications of Withdrawing from an Annuity

Before investing in an annuity plan, it is important to understand its tax implications. Since annuity payments are made regularly, the Income Tax Department considers them regular income.

Annuity plans qualify for tax deductions under Section 80C, Section 80CCC, and Section 80CCD. Under Section 80CCC of the IT Act, 1961, the lump sum paid for an annuity plan is eligible for tax deductions of up to ₹1.5 lakh in a year. 

However, the deduction limit under all three sections is combined. Under the ‘Salaries’ category, annuity payments are taxable. Therefore, pensioners can claim a standard deduction of ₹50,000 or the pension amount, whichever is less, under Section 16 of the IT Act.

The Bottom Line

It is important to note that once you start investing in an annuity, your money (aside from specified withdrawal amounts) is usually not accessible until the payout phase begins.

Withdrawing the amount early can lead to penalties. Therefore, understanding the terms and conditions is crucial when considering annuities.

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