Pros and Cons Of Annuity Policy

Pros and Cons Of Annuity Policy

Pros and Cons Of Annuity Policy - Benefits of Life Annuity In InsuranceA lot of insurance plans and retirement pension schemes are based on the concept of annuity. Financial products based on the concept of annuity accept funds from investors and invest them for growth. Then at a later point in time, a stream of payments at regular frequency are made to investors. The concept of annuities is the basis of most of the regular income products for retirement. It is essentially a contract between the issuer and the investor where the investor pays a certain amount which is the principal and the issuer pays a variable or fixed sum either as a lump sum or a series of payments.

How Annuities Work

The duration for which you pay into an annuity plan can be variable, it can either be a onetime payment or smaller payments paid annually spread over a number of years. Suppose you subscribe to an annuity plan at the start of your career, then you may opt to pay an annual amount and go on increasing the amount as your income levels go up. Thus, you can build a good corpus for your retirement by starting early.

Alternatively you may make a capital gain by way of some stock deal or property transaction and may want to buy an annuity with a one time payment.
So depending on the cash flows, you can decide which plan is most suitable for your objectives. Once the number of years as specified in the contract are complete, you will start receiving payments every month or the frequency opted for.

Depending on the scheme specifications, the annuities will continue as long as you are alive and the balance will be paid off to your heir. This option is known as life annuity. Another option is guaranteed period annuity where you receive income like payments for your lifetime and additionally on your demise, your successor is entitled to receive payments for a certain period of time. Certain annuity is where for a fixed number of years, a fixed amount is received at fixed intervals. Once the period finishes, the payments will cease, there is not lifetime clause here. Deferred annuities are plans where the annuity payments will be paid to your heir, such plans are useful when you want to create an income stream for your dependents and don’t need one for yourself and you are using it more as a tax saving tool.

Returns from Annuities

Based on the kind of returns that you are expecting, you can select the type of annuities. If you are a conservative investor, then you may prefer buying annuities which invest their corpus in fixed income instruments such as government bonds and deposits of blue-chip companies. The average returns from such instruments will be in the range of 10% p.a. If you want higher returns and are willing to take some extra risks, then you should consider investing in annuity schemes which are market linked. Such schemes will have exposure to equity markets and historically over longer durations of time such as 10 to 15 years, the returns from equity markets have always been substantially higher than equity markets.

Classification of Annuities

Annuities can be broadly classified into three types, fixed, variable and indexed. In fixed annuities, as the name suggests the issuer agrees to pay a certain interest rate for the duration the principal amount is deposited with them. In variable annuities, the investor has the option of selecting from a basket of investment options such as stocks, mutual funds and company deposits. In indexed annuities, the returns are based on some benchmark index such as the Sensex, S&P or the Dow Jones. Sometimes annuities also have a guaranteed minimum return clause so that irrespective of economic conditions and market fluctuations a lower limit for returns is decided.

Pros and Cons Of Annuity Policy - Benefits of Life Annuity In Insurance

Pros and Cons

Annuities have their share of pros and cons, so it is advisable to consider all of them before you decide to buy an annuity plan. Let us look at the pros first. The principal amount that you have invested will keep growing with attracting any tax deductions, only when you start receiving the periodic payments will the tax deduction come into the picture. Since the majority of annuity payments are scheduled for post-retirement years, the gains made in annuities will fall in the lower tax bracket. The guaranteed income part is another key benefit of annuities. It is especially useful in current volatile times when no asset class seems to be performing well.

Let us look at the disadvantages of annuities now, the terms and conditions of annuities are similar to bank deposits, so pre-mature withdrawal invites penalties. So if you looking for liquidity, then annuities may not be the right choice for you. Consider the expenses charged by the issuers of annuities, typically these expenses will be deducted from your principal amount and hence have a direct impact on your returns. Annuities charge up to 2 to 3% of the amount as fees, so you may want to consider this cost while calculating returns.

Who Should Buy?

Conservative investors who are looking for creating an income flow for their retirement years should start contributing to an annuity in their working years to build a sizeable corpus. For retired people who have received lump sums such as PPF and gratuity, buying an annuity is one of the options for generating a safe, fixed income stream with low tax liabilities.Annuities can also be used to fund long term goals such as education expenses of kids. So suppose you need to plan for expenses for your 5 year old kid who will start college in another 10 years, you can invest in an annuity which will make structured payments when he enters college. Another possibility is that you might be eligible for pension from your employer after completing a certain age and need an income flow in the years before the pension starts. An annuity plan is perfect to fill in this type of gap.

So now that we have understood how an annuity policy works, make sure to select one most suitable for your financial goals.

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