What is an Annuity?
An annuity is a contract between you and an insurance company in which you make a lump-sum payment or series of payments in exchange for recurring disbursements that begin either immediately or later.
How do they work?
- The individual begins by investing a lump sum in an annuity plan.
- The individual is then paid by the annuity on a future date or series of dates. The income might be paid monthly, quarterly, annually, or as a single sum.
- A variety of factors, including the annuity’s tenure, influence the income payout.
- Individuals might choose to receive income payments throughout the remainder of their lives or for a set amount of time.
- The income he receives is determined by whether he chose a guaranteed payout (fixed annuity) or a payout stream determined on the success of the annuity’s underlying investments (variable annuity).
Types of annuities
- Immediate annuity: These plans have no accumulation phase and begin functioning immediately after vesting. It is acquired with a lump sum, and the annuity payments begin immediately, either for a certain period of time or for the rest of one’s life.
- Deferred annuities are pension schemes in which the annuity begins after a specific date. It can be further subdivided as follows:
(i) Accumulation phase – This is the period in which you begin investing and amassing funds, and it begins on the date you pay your first premium.
(ii) Vesting phase – This is the date on which you will begin receiving insurance benefits in the form of a pension.
How do they work?
- Life annuity: You will get regular (monthly/quarterly/yearly) annuity payments from the scheme for the rest of your life. The pension terminates upon your death.
- Life annuity with a purchase price return: You will continue to receive annuity payments until you die. Following that, the insurer refunds to your nominee the initial sum used to acquire the annuity. It is an excellent alternative for people who wish to leave a legacy.
- Annuity payable for a set length of time: The annuity is to be paid for a set amount of time, such as five, ten, or fifteen years, even if the annuity buyer dies. Annuity payments are terminated when the annuitant dies or when the guaranteed time expires, whichever comes first.
- Inflation-indexed annuity: The annuity payable at a set rate, say 2% or 5%, will increase every year. Though it is not related to the real inflation rate, the logic is that it will cover some of the increase in expenses.
- Annuity for a joint life survivor: It will continue to pay until either you or your spouse dies.
- Joint life annuity with purchase price return: It will continue to pay as long as you or your spouse are alive. In the event that both parties die, the nominee is entitled to the initial investment amount.
Why to invest in an annuity?
- No Cap of Investment
- Removes the risk of reinvestment
- Sense of Safety
If a speculator faces a reserve deficit during retirement, or if he needs to make a large, unexpected use, he may be in trouble if he has locked up his benefits in an annuity.
However, there may be another financial expert who has collected a sizable enough capital that he will most likely not face a shortfall. An annuity is a suitable investment for such a speculator because of the guaranteed installment stream that it provides.