Annuities
Definition : In investment, an annuity is a series of payments made at equal intervals. Examples of annuities are regular deposits to a savings account, monthly home mortgage payments, monthly insurance payments and pension payments. Annuities can be classified by the frequency of payment dates.
Buying peace of mind in a volatile and uncertain world might appear a contradiction in terms.
But it is possible to do that by buying annuities and addressing some financial worries.
Annuities are a popular investment scheme designed to provide a steady income stream to the investor.
Two Types of Annuities
Annuities, in this sense of the word, break down into two basic types: ordinary annuities and annuities due.
- Ordinary annuities: An ordinary annuity makes (or requires) payments at the end of each period. For example, bonds generally pay interest at the end of every six months.
- Annuities due: With an annuity due, by contrast, payments come at the beginning of each period. Rent, which landlords typically require at the beginning of each month, is a common example.
Who provides the income?
Usually, an insurance company. It involves a contract between an investor and an insurance company, where the investor makes a lump sum payment to the insurer.
In return, the insurer agrees to make regular payments to the investor for a specified period.
The box below shows the type of annuities. Annuitants choose the annuity based on the periodicity, nature of the annuity and the treatment of the principal.
- On Start Time Of Annuity
- On How The Amount Is Paid
- On How Long Annuity Is Paid
Based On Annuity Start Time
Deferred Annuity: A deferred annuity product is characterized by a pre-established time gap between the accumulation of premiums and the eventual payouts to the subscriber. This time gap is commonly referred to as the “accumulation time” in insurance terms. During this period, the subscriber is required to pay premiums and only becomes eligible for annuity payouts after the accumulation time has elapsed.
Immediate Annuity: In contrast to a deferred annuity, this mode involves the payment of a fixed lump sum percentage as the premium by the subscriber. The subscriber becomes eligible to receive payouts immediately after the payment of this lump sum amount.
How The Amount Is Paid?
Guaranteed: A guaranteed annuity offers a fixed pension amount for the chosen period or until death, with no possibility of change.
Variable: Here, the returns on your investments are linked to the market. It offers the flexibility to choose the asset class you want the funds to be invested, but shifting the allocation could come at a cost.
How Long Annuity Is Paid?
The third category is based on how long the annuity is paid and what happens to the principal amount after the term. Here are some of the modes of annuity payment based on periodicity.
Lumpsum: A lump-sum annuity, as the name suggests, has the option of a one-time, lump-sum payout. This means that depending on the terms and conditions, a subscriber can withdraw a lump-sum amount (usually a set percentage of the entire corpus) after a particular time.
Life Annuity: Guaranteed pension till the end of life.
Return Of Purchase Price: Here the principal is paid back to the survivor on completion of the term or to the nominee on death of the annuitant. The other types are payment of annuity for joint holders and then the survivor; and annuity to the principal holder and then to spouse on death.
Ordinary Annuities: Imagine you decide to save $1,000 every year for five years in an account that earns 5% interest annually. An ordinary annuity assumes these payments are made at the end of each year. Thanks to the magic of compound interest, your money grows over time more than it would just sitting in a standard savings account. Specifically, after those five years, you’d have accumulated about $5,525.64. This growth happens because each dollar has more time to earn interest, making your initial investments increasingly valuable.
Annuities Due: On the flip side, with annuities due, payments are made at the start of each period. If you were to invest $1,000 at the beginning of each year under the same conditions, you’d end up with about $5,801.91 after five years. The increase compared to an ordinary annuity comes from the fact that each payment has an extra period to accrue interest, boosting your total savings even more.
Calculating the future value of these annuities helps you understand how much your series of payments will be worth down the road, which is super useful whether you’re saving for retirement, a big trip, or just looking to grow your wealth. Similarly, knowing the present value can guide you in understanding how much you would need to invest today to achieve a certain financial goal in the future.
Who Should Buy Annuities?
Annuities can be a great investment option for those who are looking for a steady stream of income in their retirement years. Here are some scenarios when one should consider buying an annuity plan:
Planning for Retirement: Annuities are a good investment option for those who are planning for retirement and want to ensure a reliable source of income in their retirement years. An annuity can provide a steady stream of income for a specified period.
Inheriting a Lump Sum: If you have inherited a lump sum of money, you may want to consider investing in an annuity. An annuity can help you turn that lump sum into a regular stream of income over a specified period.
High-Interest Rates: In the current high-interest rate environment, fixed annuities are a viable investment option. This is the time to secure fixed annuity plans, as insurance companies may offer higher guaranteed returns.
Longevity Risk: Annuities can also be a suitable investment option for individuals concerned about longevity risk. Longevity risk is the risk of outliving your savings in retirement. An annuity can provide a dependable source of income for a specified period, helping to reduce the risk of running out of savings during retirement.
Like all financial products, annuities may be appropriate for some but not suitable for everyone. Before making any investment decisions, it’s essential to consult a financial advisor to determine whether an annuity is the right investment strategy for you.
How to Use Annuity Calculator?
1. Income Details: Kick things off by inputting your current annual income. This figure is crucial because it reflects your saving potential. Additionally, factor in your expected income growth rate over the years. This helps in adjusting your plan as your earning capacity increases.
2. Demographic Information: Your age and the age at which you plan to retire are also important. These figures help determine the length of your investment period, or accumulation phase. Starting early can be advantageous as it potentially increases your retirement payouts due to a longer investment duration.
3. Regular Expenses: Understanding your regular expenses is key to determining your saving and investing capacity. Lower expenses might mean higher potential savings, but remember, expenses are likely to increase over time due to inflation.
4. Current Savings: If you’ve already got some savings set aside for retirement, that’s great! These savings, especially if started early, can grow significantly thanks to compounding interest. Whether your savings are in fixed deposits, stocks, or mutual funds, consider how they contribute to your retirement plan.
5. Inflation Trends: Inflation can erode the purchasing power of your savings over time. If inflation rates rise, you may need to save more to achieve your desired retirement fund. Also, remember that your regular expenses are likely to increase, which can impact the real value of your investment returns.
By carefully considering these inputs, an annuity calculator can give you a clearer picture of how much you need to invest today to enjoy a comfortable retirement tomorrow. It’s a tool that brings clarity to the complex process of planning for the future, making it easier for you to make informed decisions about your financial well-being.
Annuities Legal regimes
The Indian Succession Act, 1925
Chapter XX.- Of Bequests of Annuities
173. Annuity created by will payable for life only unless contrary intention appears by will.-
Where an annuity is created by will, the legatee is entitled to receive it for his life only, unless a contrary intention appears by the will, notwithstanding that the annuity is directed to be paid out of the property generally, or that a sum of money is bequeathed to be invested in the purchase of it.
Illustrations
(i) A bequeaths to B 500 rupees a year. B is entitled during his life to receive the annual sum of 500 rupees.
(ii) A bequeaths to B the sum of 500 rupees monthly. B is entitled during his life to receive the sum of 500 rupees every month.
(iii) A bequeaths an annuity of 500 rupees to B for life, and on B’s death to C. B is entitled to an annuity of 500 rupees during his life. C, if he survives B, is entitled to an annuity of 500 rupees from B’s death until his own death.
174. Period of vesting where will directs that annuity be provided out of proceeds of property, or out of property generally, or where money bequeathed to be invested in purchase of annuity.-
Where the will directs that an annuity shall be provided for any person out of the proceeds of property, or out of property generally, or where money is bequeathed to be invested in the purchase of any annuity for any person, on the testator’s death, the legacy vests in interest in the legatee, and he is entitled at his option to have an annuity purchased for him or to receive the money appropriated for that purpose by the will.
Illustrations
(i) A by his will directs that his executors shall, out of his property, purchase an annuity of 1,000 rupees for B. B is entitled at his option to have an annuity of 1,000 rupees for his life purchased for him or to receive such a sum as will be sufficient for the purchase of such an annuity.
(ii) A bequeaths a fund to B for his life, and directs that after B’s death, it shall be laid out in the purchase of an annuity for C. B and C survive the testator. C dies in B’S lifetime. On B’s death the,fund belongs to the representative of C.
175. Abatement of annuity.-
Where an annuity is bequeathed, but the assets of the testator are not sufficient to pay all the legacies given by the will, the annuity shall abate in the same proportion as the other pecuniary legacies given by the will.
176. Where gift of annuity and residuary gift, whole annuity to be first satisfied.-
Where there is a gift of an annuity and a residuary gift, the whole of the annuity is to be satisfied before any part of the residue is paid to the residuary legatee, and, if necessary, the capital of the testator’s estate shall be applied for that purpose.
