A deferred annuity is a financial product designed specifically for your retirement. It is an insurance contract that allows the insured to save funds during their earning years and earn stable income during their retirement years. Unlike immediate annuity plans, the payout from deferred plans starts only after a predetermined future date. This steady and guaranteed income keeps you financially secured in the retirement years, allowing you to fulfil your post-retirement goals and meet expenses.
However, understanding the meaning of deferred annuity is not enough. You also need to understand how it works and the various subtypes, advantages, and disadvantages to make a sound retirement planning choice. We cover all these nuances in the following sections.
Types of deferred annuities
Now that we have covered what is a deferred annuity, it is time to understand the different types. Deferred annuities can be classified into the following types depending on the way interest is calculated on the invested sum:
- Fixed annuities: A fixed deferred annuity is a type of annuity that provides you with a fixed rate of return on the amount invested, much like non-cumulative fixed deposit. The insurance company agrees to pay a fixed interest rate on the investment in the payout phase, regardless of market fluctuations. At the end of the accumulation phase, you are entitled to fixed and regular income payments. Since the minimum amount payable is guaranteed and decided in advance, you know exactly how much you will have in retirement. While the predictable rate of interest can help add stability to your retirement planning, it might not beat inflation. If you want to diversify your investment portfolio, you can consider a stable investment option like Fixed Deposit.
- Variable annuities: Variable annuities do not offer a fixed rate of return. The funds invested in purchasing the annuity are invested in various investment options like stocks, mutual funds, and bonds. You can choose the sub-accounts depending on your risk appetite, age, and other factors. The value of your investment account fluctuates depending on the performance of the assets in your portfolio. In other words, returns vary according to asset performance and market conditions during the payout phase. Variable deferred annuities are a great way of ensuring regular income flow as well as corpus growth.
- Indexed annuities: Also called fixed-index annuities, indexed deferred annuities provide returns based on the market performance of a particular market index, such as S&P 500. Typically, indexed annuities place caps on the highest possible gains and highest possible loss, allowing you to benefit from market-linked high yields but also enjoy some protection during market declines. Simply put, this deferred annuity variant offers the best of both worlds.
Understanding how deferred annuity works
Deferred annuity plans offer a regular income but after a certain date. Depending on the plan you pick, you make premium payments for a certain number of years (premium paying term) and then wait for the deferment period to end, after which your income payouts begin. You can choose to make either a lump-sum payment or a series of monthly, quarterly, or yearly payments over time. This premium-paying term is also called the accumulation phase, which is when your contributions continue to grow on a tax-deferred basis. While for most plans, annuity payments typically start at retirement at the age of 60 years, some allow investors to customise both the premium paying term and deferment period.
Deferred annuity payments can be structured in different ways to suit your retirement needs. Most insurance providers allow you to choose payout frequencies, including monthly, quarterly, and annual annuity payouts. Life annuity plans offer annuity payments for the rest of your life, while joint annuity plans continue payments for your spouse even after your demise.
Advantages of a deferred annuity
- Multiple payout options: Deferred annuity schemes offer you ample flexibility to choose premium payment periods and payout options. You can choose from monthly, quarterly, half-yearly, or yearly payout options to suit your retirement needs and goals.
Bajaj Finance also offers flexible payout options, including monthly, quarterly, half-yearly, annually, or at maturity, on their fixed deposit. - Flexible deferment period: These plans give you the freedom to choose when you wish to start receiving regular income. However, most providers allow you to choose from a pre-given deferment window.
- Guaranteed post-retirement income: You can enjoy a steady income stream in your golden years. This guaranteed income is disclosed beforehand, eliminating uncertainty and helping you plan your finances better.
- Bigger payouts: Deferred annuity investments earn interest to grow in value until the annuitisation starts. With variable and indexed annuity plans, you can also benefit from potentially higher market-linked returns. This allows you to earn substantially bigger payouts during the withdrawal period for a better life post-retirement.
- Tax benefits: Your contributions to a deferred annuity plan are eligible for tax deductions under section 80(C) of the Income Tax Act, 1961. Additionally, the annuity earnings are tax-deferred until withdrawn.
Disadvantages of a deferred annuity
- Surrender charges and low liquidity: Premature withdrawals from a deferred annuity plan are difficult, given the hefty surrender charges associated with such plans. This limits your access to the funds for years and minimises liquidity.
- Taxation on payouts: Deferred annuity payouts are not tax-exempt. The payouts received are classified under ‘Income from Salaries’ and taxed as per your applicable tax slab.
- Investment risk with variable annuities: The rate of returns on variable annuities can fluctuate depending on the prevailing market conditions. This can potentially impact your retirement income.
- Complexity: Deferred annuity plans have long and complicated contracts that can be difficult to understand. They may need to consult a financial advisor to understand the details of these plans, including fees and charges, as well as complex investment terms.
Conclusion: Who should buy a deferred annuity
A deferred annuity plan is best suited for young individuals starting their careers with several years left before retirement. Assuming they have minimal responsibilities at this stage, they can stay invested for a long duration, making piecemeal contributions to secure a steady income flow for their post-retirement years.
While deferred annuity plans are a great source of stable and reliable retirement income, you can complement them with other safe investments like FDs. Fixed deposits, like the Bajaj Finance FD, offer high interest rates of up to 8.65% p.a., allowing you to boost your retirement corpus without risks. For senior citizens, the Bajaj Finance FD offers an additional interest rate of up to 0.40% p.a., making them a great option to park extra funds post-retirement.
