One major advantage of annuities offered by life insurers is that there is no cap on investment. It removes the risk of re-investment at a time of low interest rate regimes
The biggest challenge that an individual faces after retirement is how to invest his savings such that he can lead the rest of his life without any financial difficulties. Here, the risk is that one could possibly outlive one’s savings. To avoid such risks, one can consider annuity insurance plans. Let us discuss the same in detail.
What is an annuity insurance plan?
Annuity is basically an insurance product that provides a guaranteed income either for life or for a stipulated duration but does not provide life insurance cover. Insurance companies bear the possible risk that an individual may outlive his/her own resources. These insurance plans ensure a regular life-long income via a one-time lump sum or regular investments.
With a fixed annuity product, one knows well in advance how much he/she will receive when the annuitisation phase starts, i.e., when the insurance company starts making the payments back. Contrary to the above, variable annuities work in a different style. Under this scheme, the return is based on the performance of a basket of stock and bond products. Though there is a chance for growth as compared to a fixed annuity, there exists a significant risk.
However, some insurance companies allow one to buy a rider that offers a guaranteed minimum withdrawal, even when the market is not performing well. Under an immediate annuity plan, one pays the insurance company a lump sum and starts collecting regular payments immediately. Whereas, in a deferred annuity product, one deposits a lump sum amount over a period of time. The payment starts after a stated period, generally after turning 60. Apart from the above four major types of annuity plans, there are some other modified plans.
One of the major advantages of investing in annuities offered by life insurance companies is that there is no cap on investment. Further, it removes the risk of re-investment, especially when our country is moving towards lower interest rate regime. It also offers a sense of safety because an annuity gives a return pay-out month on month, quarterly, half-yearly, annually, as the case may be.
Though annuities provide you with a secured income after retirement for the rest of your life, they have their disadvantages, too. From the income tax point of view, there is no advantage because the payouts are taxable as per the tax slab of the individual. Another major drawback of annuity is that they are not very liquid investments. Insurance companies generally do not allow premature surrender of annuity plans. Once an investor buys an annuity plan, his principal gets locked and he cannot withdraw the same for any unforeseen financial exigencies. Sometimes, owning an annuity may entail higher fees and expenses than some other investment vehicles.
Read the fine print
One should read the fine print of the contract of the insurance company for annual contract charges, surrender charges, how withdrawals can affect your annuity’s death / living benefit, etc. Before committing to an annuity contract, check the insurance company’s stability and financial strength by referring to the reports of independent rating agencies.
To lead a comfortable and financially independent life after retirement, annuity plans might be your best bet. However, do understand the associated risks and drawbacks before investing.
(The writer is a professor of finance & accounting, IIM Tiruchirappalli)
Annuity is an insurance product that provides a guaranteed income either for life or for a stipulated duration of time
Annuity pay-outs are taxable as per the tax slab of the individual
Once an investor buys an annuity plan, his principal gets locked and he cannot withdraw it for any unforeseen financial exigencies
One can choose an immediate annuity plan or go for a deferred annuity plan