Annuity is like a pension product that is designed by insurance companies to provide periodic income to policyholders after a specific period of time i.e. post retirement period. There are two phases in annuity products; one is a period of accumulation in which policyholder pays premium to insurers and the other is the period of distribution where payments are made to policyholder by the insurance companies. Annuity product reduces the impact of interest rate risk as the insurance companies are obliged to pay pre-specified interest rate throughout the policy irrespective of prevailing interest rate regime. Another benefit of annuity product is longevity.
Types of annuity:
On the basis of payment:
Immediate annuity - These products are purchased on single or lump-sum payment.Here, the interest rate competes favorably with bank CDs. These products are suitable in pre-retirement phase.
Deferred annuity - It can be bought through lump-sum payment as well as through an installment plan. These products give benefit of compounding interest on returns generated.
On the basis of amount:
Fixed rate annuity - These products ensure payment of fixed interest rate throughout the policy, pre-specified in the insurance contract.
Variable annuity - Here, the monthly/quarterly/yearly annuity payments vary with the prevailing market conditions as the insurer invests some portion of investment in securities. These products allow policyholders to decide or change their asset allocation thereby controlling the risk associated with market volatility.
Equity indexed annuity - These products are similar to mutual fund products as the insurance companies park the investments in equity and equity related securities so as to generate capital appreciation. These products are considered as most risky but chances of getting optimal returns are comparatively high.
On the basis of payments:Annuity certain - It ensures monthly flow of income for a specified period of time irrespective of annuitant’s life. Insurance company will make payments to the beneficiary in case of any untoward event with annuitant for the balance period. If an investor invests in annuity certain for 10 years he/she will surely get annuity payment for 10 years.
Life annuity - These products ensure lifetime flow of income till the annuitant’s death. Insurance companies will not make payments to the beneficiary.
Joint life annuity - It covers two individuals of a family. Under these products, insurance companies have to make payments till the death of both members.
Annuity with return of purchase price - Like whole life insurance products, these products also ensure payback of principal amount on the death of annuitant. However, the monthly/quarterly/yearly flow of income is comparatively low.
Increasing annuity - Here the annuity payment increases with each passing year.
Taxation: Under section 80CCC of IT Act, the premium paid to annuity product is liable for deduction up to Rs 1 lakh from annual income. However, the deduction will be reversed if the policy lapses. Also, payment received in the hands of policyholder or nominee will be taxable.
At present, insurance companies like LIC, SBI Life, ICICI Prudential, Max, Metlife and Tata AIG are offering various annuity products.