What are Annuities & How They Work

Aisha: Mansi, I’ve been hearing a lot about annuities lately, but I’m still not sure if they’re right for me. Can you shed some light on them?

Mansi: Of course, Aisha. Annuities are essentially insurance products that provide a steady income stream, typically for retirement. You pay a lump sum or make periodic payments, and in return, you receive regular payments for a specified period or for the rest of your life.

Aisha: That sounds interesting.

Mansi: Yeah, it sounds interesting to many of us but we need to make sure whether they are suitable investment options are not. Read this blog on annuity written by LXME.

Aisha: Oh, Thank you for the blog.

For every woman, retirement planning is one of the important goals because women live longer than men, they face the gender pay gap, take career breaks, etc. Which is why retirement planning become very essential.

There are various investment options available for retirement and one of them is annuities. Don’t know what it is? Then let’s dive into it and understand what are annuities, how annuities work, the benefits of annuities, types of annuities, etc.

What are Annuities?

An annuity is an agreement between the insurance company and the individual wherein the individual pays a lump sum to the insurance company, and in return, they provide you with payouts either at regular intervals or immediately, depending on your choice of annuity and needs. 

Types of Annuities

1. Immediate Annuities

• What it is? You pay a lump sum upfront.
• How it works? You start receiving regular payments right away.

2. Deferred Annuities

• What it is? You invest money over time.
• How it works? You receive payments starting at a future date.

3. Fixed Annuities

• What it is? Provides guaranteed payments.
• How it works? The payment amounts stay the same over time.

4. Variable Annuities

• What it is? Payments can vary.
• How it works? Your payouts are dependent on the performance of your chosen investments.

5. Indexed Annuities

• What it is? The returns are linked to a market index.
• How it works? Your earnings depend on the performance of a specific market index, like the Nifty 50 or Sensex.

How Annuities Work?

• During the accumulation phase, you can pay in either a lump sum or in installments and the funds grow tax-free until you begin receiving payments.
• During the payout phase, the insurance company will make regular payments to you.
• Different payment options: You have the option of receiving payments for a fixed number of years, your entire life, or the lifetimes of both you and a beneficiary.
• Tax benefits: Includes tax-deferred growth, which means you will not have to pay income taxes on the earnings from your annuity investments till the time you begin making withdrawals or getting periodic payments.

Benefits of Annuities

Some of the benefits of annuities are written below:

1. Steady Income: Offers a consistent income source after retirement.
2. Tax Benefits: Your investment grows tax-deferred. which means you will not have to pay income taxes on the earnings from your annuity investments till the time you begin making withdrawals or getting periodic payments.
3. Financial Security: Ensures that you do not outlive your savings.

Drawbacks of Annuities

1. Complexity: It can be difficult to understand.
2. Fees: Annuities can carry substantial fees.
3. Early Withdrawal Penalties: There may be penalties if you withdraw money too early.
4. Low return: As it has an insurance component, the costs involved are higher and real return is lower

Should you invest in Annuities?

Never Mix Insurance and Investment together

– The saying “never mix investment and insurance” suggests that it is not a good idea to combine investment and insurance products. 

-This is because the primary purpose of insurance is to provide financial protection against unexpected events, such as death, disability, or illness, while the primary purpose of investment is to generate a return on investment over a period of time.

-It is generally recommended that individuals purchase insurance products, such as term life and health insurance, to provide financial protection against unexpected events. Separately, they can invest in a diversified portfolio of assets, such as equity, debt, and gold to achieve their investment goals over time.

– By separating insurance and investment needs, individuals can better tailor their financial plan to their unique situation and ensure they get the best possible value for their money.

– So, ideally one should opt for pure life insurance i.e. Term Insurance which offers a higher sum assured at a lower cost. 

Ideally, you should diversify your retirement portfolio against different asset classes like equity, debt, and gold which will help you get inflation-beating returns over a longer period of time, stability in your investment portfolio, and will hedge your investments against inflation. 

And yes, you can invest in all three asset classes through mutual funds. You can create your retirement fund in mutual funds and during retirement, you can opt for a Systematic Withdrawal Plan (SWP) through which you can get periodical income.

Check out LXME – investment platform for women for goal and time-based portfolios that are well-researched and curated by experts which will help in investment for women 

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