One of the primary reasons for retirement planning for a salaried individual or otherwise is to ensure that you have enough money to support your lifestyle and cover your expenses after retirement.
It may include everything from paying for basic living expenses to funding travel and even hobbies. Retirement planning helps you think about your long-term financial goals and how you can achieve them.
Even if you think you have enough money saved for retirement, unexpected expenses can arise that can derail your plans. For example, you may need to pay for unexpected medical expenses or home repairs.
Annuity plays an important role in retirement planning.
What is an annuity?
According to the information available on Pension Sanchay, the financial literacy portal of PFRDA, annuity is a fixed sum of money paid to someone (like a financial institution or an insurer) periodically (Monthly, Quarterly, Half-yearly, Yearly) typically for the rest of their life or for the period one chooses.
The goal of annuities is to provide a steady stream of income during retirement.
Also Read: Retirement Planning: 10 Tips For Gen Zs To Secure Their Future
Effectively, an annuity is a contract between a person (called Annuitant) and an insurance company in which one makes a lump sum payment or series of payments and in return obtain regular payouts beginning either immediately or at some point in the future.
In simple words, an annuity in retirement is a financial product that provides a guaranteed stream of income for a certain period of time, often for the remainder of a person’s life. An annuity is typically purchased from an insurance company, and the purchaser pays a lump sum or a series of payments to the insurer in exchange for the promise of regular payments in the future.
It’s important to carefully consider the terms of an annuity before purchasing one, as there may be fees or penalties associated with early withdrawals or changes to the payout structure.
Before understanding how an annuity works it is very important to understand and know the different parties to an annuity.
–Insurer/ Annuity Provider– The company paying the regular payments or annuity. Generally this would be an insurance company.
–Annuitant– The person who is the recipient of an annuity payment.
– Nominee– The person who receives the funds after the demise of the annuitant. The nominee could be a spouse, child/ children or parents. The annuitant chooses or nominates his/her nominee at the time of buying the annuity policy. The insured person can nominate one or more people as his/her nominee.
Factors affecting pension/annuity amount according to Pension Sanchay
To understand the factors that will impact the pension size we have to step into the shoes of the annuity provider.
The insurer/ annuity provider is betting against the annuitant’s longevity- lesser is the payment period post commencement of the annuity, better is the situation for the insurer/ annuity provider because the uncertainty and fluctuations with which it has to deal with, will be low and for a lesser period.
For example, there is a world where every person will live up to 75 years. A person of 50 years in this world buys an annuity such that he/she will be paid the annuity till the end of life i.e. 75 years. Similarly there is another person who takes the annuity at 65 years and he/she will get the payments for 10 years.
For the first case, the annuity provider would need to make arrangements for making payments for 25 years; for any financial contract that is a very long time!
In the second case the payment period for the company is 10 years, a long time but nevertheless less than 25 years in the first case.
Pension amounts available increase as your entry age in the annuity plans increases. There is a direct correlation between the entry age and pension amount available- higher the entry age, higher is the pension amount.
Other factors affecting pension are as follows:
Options added in the plan chosen- One gets the highest pension income (annuity) with the basic plan that covers only the annuitant.
Any options one adds (like annuity to spouse and/ or ROC to last survivor) only lowers the pension amount. That’s because the extra additions increase the cost of the annuity provider.
Age of spouse- In case one chooses a plan in which the pension is payable to spouse, the age of spouse would also impact the annuity rate and the pension available.
Examples of various annuity plans available in the market
There are many types of annuities- some payable only till the annuitant is alive, some payable to spouse after death of the main annuitant, some even payable to the nominee after death of main annuitant and spouse.
Annuity payable for life– Pension for life to the annuitant till he/she is alive. After death of annuitant, no pension to surviving spouse/ nominee and the purchase price is lost.
Annuity payable for 5/10/15/20 yrs and life thereafter- Pension for life to the annuitant till he/she is alive. In case the annuitant dies within 5/10/15/20 years, the spouse gets annuity for the remaining period only.
After such a period, the purchase price i.e. lump sum is lost. For eg. say an annuitant chooses a 15 year plan. If annuitant dies after 10 years, pension will be available to the surviving spouse. But if the annuitant dies after 15 years, no pension will be available to the surviving spouse and the purchase price will be lost.
Also, in case the spouse has died before the annuitant, the purchase price is lost.
Annuity payable for life with ROC (Return of Capital) on death of annuitant– Pension for life to the annuitant till he/she is alive. After death of annuitant, the purchase price used to buy annuity is returned to the nominee.
Annuity payable for life increasing at 3% simple p.a.- Pension for life to the annuitant till he/she is alive increasing at a simple rate of 3% per annum. After the death of annuitant, no pension to the surviving spouse/ nominee and the purchase price is lost.
Annuity payable for life with 50% annuity payable to spouse on death of annuitant– Pension for life to the annuitant till he/she is alive. After death of annuitant, 50% pension to surviving spouse. After the death of a spouse the purchase price is lost. Also, in case the spouse has died before the annuitant, the purchase price is lost.
Annuity payable for life with 100% annuity payable to spouse on death of annuitant– Pension for life to the annuitant till he/she is alive. After death of annuitant, 100% pension to surviving spouse. After the death of a spouse the purchase price is lost. Also, in case the spouse has died before the annuitant, the purchase price is lost.
Annuity payable for life with 100% annuity payable to spouse on death of annuitant with ROC on death of Last Survivor– Pension for life to the annuitant till he/she is alive. After death of annuitant, 100% pension to surviving spouse. After the death of a spouse the lump sum used to buy the annuity is returned to the last survivor.
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