Introduction
Having a fixed and stable income is important to lead a financially independent life. An annuity is one of the few ways in which you can enjoy a fixed income at a pre-decided time. Whether trying to make a retirement plan or looking for a source of income, buying an annuity can be a great option.
What is Annuity
An annuity is nothing but a contract between you and the insurance company, wherein you have to pay a lump sum to the insurance company and they give you a payout at decided periods of time or immediately as per your choice and requirement.
Types of Annuity
The two main types of annuity are as follows:
- Immediate annuity plans
Immediate annuity plans have no accumulation phase, the plan starts working right from the first phase. The annuity is placed with a lump sum and the payment of the annuity also starts immediately.
- Deferred Annuity
A deferred annuity is an annuity that starts with a certain date and is the one that includes pension plans for post-retirement income. This annuity is further divided into a fixed annuity and a variable annuity. Let’s discuss these subtypes in brief below:
-- Fixed annuity
A fixed annuity is one that gives you a fixed amount of income throughout the period of the annuity. When you purchase the annuity plan, the amount of income is pre decided and guaranteed to be paid to you. As this amount is pre-decided, it does not get affected by any market fluctuations and remains the same throughout.
-- Variable annuity
As opposed to a fixed annuity, a variable annuity is subject to market fluctuations. The income payouts through this annuity depend on the performance of the annuity in the market. The annuity goes through two phases—the accumulation phase and the vesting phase. The accumulation phase begins when you first invest in the annuity. The vesting phase begins from the day you start to receive the payments from the annuity.
How do Annuities work?
After discussing the different types of annuities, let’s discuss how annuities work and how you can buy an annuity for your benefit.
To start with, you have to make a lump sum investment towards an annuity plan. After making this lump sum payment, the annuity makes the payment for you on a future date. You can dole out the income on a weekly or monthly basis or even as a lump sum. The way in which the income is paid out depends on the tenure of the annuity. Depending on the tenure of the annuity, you can decide whether you want to receive the income throughout your life or a fixed time period.
The income offered by the annuity will also differ based on whether the annuity is fixed or variable. If the annuity is fixed you can opt for guaranteed payment, whereas with a variable annuity, the payment is based on the performance of the annuity.
Uses of Annuities
Tax-deferred growth.- You will not pay income taxes on the earnings from your annuity investments till you begin making withdrawals or getting periodic payments. Note that withdrawals before age 59½ may be subject to an additional 10% tax.
Unlimited contributions- There is no limit to the amount of after-tax money you can place into an annuity, despite your income level or sources of income.
Choice of investment options - Fixed annuities extends a stated rate of return for a specified period. Variable annuities include various investment options, such as stocks, bonds, and money market instruments, that vary with market conditions.
No necessary withdrawals- If your annuity is not part of an IRA or a retirement plan, you are not expected to begin taking minimum distributions after age 72.
Death benefit. Payout methods include insurance features that confirm payment to your designated beneficiaries if you die before your withdrawals begin. In most cases, this payment does not need to pass through probate.
Why buy an Annuity?
As we have already discussed above, the objective of an annuity plan is to give you a stable source of income. This simply means that buying an annuity plan is a guaranteed way of securing your post-retirement life. An annuity plan gives you a guaranteed source of income for life. So if you are planning to secure your post-retirement life and have a stable source of income for life even when your working days are over, then buying an annuity plan may actually turn out to be a good option for you.
Advantage of Annuity
Now that we have talked about annuities in detail and discussed the types of annuities, it is now time to see the different advantages of annuities. Some of these advantages of annuity are as follows:
The annuity has many advantages but one of the biggest advantages is that it provides a regular income source throughout life, even after retirement.
There are different annuity plans available for you to choose from. This allows you to choose the annuity plan that best suits your requirement at the time. Annuity plans are quite flexible and allow you to customize your plans according to your needs. You can choose a single life plan or a joint life plan for you and your partner.
According to the Income Tax Act, of 1961 you get certain tax benefits by purchasing an annuity plan.
Examples of Annuities
The two most common annuity examples are the Pension annuity plans and the immediate annuity plan. A pension annuity plan is a guaranteed annuity plan that gives you fix income throughout your lifetime. Whereas, an immediate annuity plan is a traditional annuity plan that allows you to choose from different plans based on your requirements.
Bottom line
So to conclude, an annuity investment is one of the best ways of having a fixed source of income throughout your lifetime. It is also a great way of planning your post-retirement life and keeping a steady income even after retirement.
