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Complete Guide on Annuity Plans – Definition, Types and Calculations

Complete Guide on Annuity Plans - Definition, Types and Calculations

The literal annuity meaning is a series of payments paid annually for the lifetime of the investors. These series of payments create a source of regular income and are, therefore, favoured among investors. Life insurance companies offer annuity plans which are designed to cater to your retirement needs. These plans are also called pension plans. Let’s understand annuity meaning in the context of life insurance and its different aspects –

What is an annuity plan?

An annuity plan is an insurance plan which promises lifetime annuity to the policyholder. Annuity insurance plans create a retirement corpus from which periodic annuities are paid to the policyholder throughout his/her lifetime.

Features of an annuity plan

Annuity plans have the following features which are unique to them –

  • The individual who invests in an annuity plan is called the annuitant. The annuity is payable to the annuitant
  • Annuity is called the reverse of life insurance. Under life insurance plans you pay regular premiums and get a lump sum benefit. Under annuity plans, however, you pay a lump sum benefit to get regular annuities. Due to this nature of annuities, they are called the reverse of life insurance
  • There are two phases under a pension plan – accumulation phase and annuity phase. Accumulation phase is when you pay premiums to create a retirement corpus. Annuity phase, on the other hand, is when the insurance company pays you annuities
  • Annuities can be paid annually, half-yearly, monthly or quarterly
  • Annuities can be of a fixed amount or you can choose to avail increasing amounts at every pay-outs
  • You can postpone receiving annuity till a later age. This postponement is called deferment. The period up to which the annuity payments are postponed is called the deferment period
  • The age from which annuity payments start is called the vesting age. The date of commencement of annuity is called vesting date
  • The amount of the annuity is calculated depending on the corpus, the vesting age, annuity pay-out option selected and the frequency of payments

Types of annuity plans

There are two types of annuity plans – deferred annuity and immediate annuity. Let’s understand both these plans in detail and how each works –

Deferred annuity plans

Deferred annuity plans are those which allow you a time period to create a retirement corpus. Under these plans, there is a deferment period during which you can contribute towards accumulating a corpus. Then the annuity phase starts wherein the accumulated corpus is used to pay annuities. Deferred annuity plans, therefore, let you, first create a corpus and then receive annuities from it.

The features of deferred annuity plans are as follows –

  • These plans can be issued either as traditional plans or unit linked plans
  • You have the flexibility to choose the deferment period
  • When the deferment period is over and the annuity phase begins, you have the option of commuting part of your accumulated corpus. You can commute and receive one-third of the corpus in cash
  • There is a death benefit under these plans. In case of death during the deferment period, the death benefit is paid
  • If you choose a unit linked plan, you can do partial withdrawals during the policy tenure

How do deferred annuity plans work?

Here’s how deferred annuity plans work –

annuity plans work

Immediate annuity plans

Another type of annuity plan is an immediate annuity plan. Under immediate annuity plans, there is no deferment period. You start receiving annuities right after you buy the plan. Here are the features of immediate annuity plans –

  • Annuities are paid quarterly, half-yearly, monthly or annually as you choose
  • You have to pay a single premium to buy an immediate annuity plan. This single premium is called the purchase price
  • There are different annuity payment options to choose from. Common options include the following –
      • Annuity for life
      • Annuity for a certain period and thereafter for the rest of life
      • Increasing annuity for life
      • Annuity for life with return of purchase price
      • Joint life annuity
      • Joint life annuity with return of purchase price
  • Under the joint-life annuity, there are two annuitants. One is the primary annuitant who buys the policy. Annuities are paid till the lifetime of the primary annuitant. The second is the secondary annuitant who is usually the spouse, of the primary annuitant. If the primary annuitant dies and the spouse is alive, annuities would be paid until the surviving spouse’s lifetime
  • The annuity rates under immediate annuity plans are fixed

How do immediate annuity plans work?

You have to pay a lump-sum premium to buy the plan. You also choose the annuity frequency. Once the plan is bought, the annuity payments start from the next frequency. For instance, if you buy a plan on 1st January and choose a monthly frequency of receiving an annuity, annuity payments would start from 1st February onwards.

Annuities are paid for life as per the annuity option that you have selected. If you choose a joint-life annuity, the annuity payments would continue even after your death until your spouse is alive. There is no death benefit under annuities except in cases where the purchase price is refunded back.

Annuity calculator

The amount of annuity that you receive depends on a lot of factors. These factors include the following –

  • Your age
  • The vesting age
  • The annuity corpus that you have created (in case of deferred annuities) or the purchase price paid (in case of immediate annuities)
  • Type of annuity pay-out option you select (in case of immediate annuities)
  • Annuity payout frequency

There are online annuity calculators which calculate and tell you the annuity that you would get depending on the above-mentioned factors. You can enter the relevant details and the calculator would calculate and tell you the amount of annuity instalment.

How to select an annuity plan?

There are two types of annuity plans and the ideal one for you would depend on your needs. Here’s how you can select the best annuity plan –

  • Deferred annuity plan – these plans make sense when you have time to build a retirement corpus. You can choose a plan as per the desired tenure, pay premiums and create a good corpus for your retirement. Thereafter, when you retire, the deferred annuity plan would have created a corpus which would help you avail annuity incomes for your lifetime
  • Immediate annuity plan – these plans are ideal if you have already retired or will be retiring in a couple of years and you have a lump sum retirement corpus at your disposal. You can invest the corpus and avail lifelong incomes. Moreover, you can add your spouse as the secondary annuitant and choose a joint-life annuity plan for securing your spouse’s financial needs even in your absence

So, depending on your life stage, choose the best type of annuity plan.

Tax implication of annuity insurance plans

Life insurance annuity plans are taxed differently than other types of life insurance plans. The tax implications of annuity plans are as follows –

  • Premium paid

The premium paid would be allowed as a deduction under Section 80CCC. The maximum limit of deduction allowed is INR 1.5 lakhs. This limit includes the deduction allowed under Section 80C.

  • Commuted pension

Under deferred annuity plans, 1/3rd of the corpus can be commuted and received in cash. This commuted pension is tax-free in your hands. No tax is levied on the commuted pension under Section 10 (10A) of the Income Tax Act.

  • Annuities

The annuities received are considered to be an income in your hands. As such, the annuity that you receive would be taxed at your income tax slab rates.

Now you know what is an annuity and how it works. Life insurance annuity plans help you create a fund for your golden years. You can, therefore, invest in deferred or immediate annuity plans and earmark a fund for your retirement years.

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