This post initially appeared on Advisorkhoj.com.
Pension plans are life insurance plans wherein the insurance company provides a stream of annuity payouts to the policyholder. Such annuity payouts are provided out of the funds contributed by the policyholder either in lump sum or in instalments depending on the type of the pension plan chosen.
Annuity payouts are paid throughout the lifetime of the policyholder and if he dies, the annuity payouts stop. In many pension plans, the annuity payouts continue to be paid even after the policyholder’s death. These payouts are made to the policyholder’s spouse and are called joint life annuities.
Pension plans are of two distinct types – Immediate Annuity Plans and Deferred Annuity Plans.
Immediate Annuity Plans
These are the simplest and the purest form of annuity plans. Under the plan, the policyholder deposits a lump sum amount with the insurance company which is called the purchase price and buys the plan. The annuity payouts start immediately after the plan commences and the first payout is made from the next frequency (monthly, quarterly, half-yearly or annually) as chosen by the policyholder.
For example – Arun buys an Immediate Annuity Plan by paying Rs 1 lakh as the purchase price on January 1, 2016. He chooses to receive annuity payouts every month. Thus, the company would start making such annuity payouts from February 1, 2016 and would continue paying annuity on the first of every following month till such time the policyholder is alive.
The plan promises various benefit payout options and the policyholder might choose any option as desired. The available benefit options under Immediate Annuity Plans are as follows:
The simplest form of the plan where annuity payouts are paid during the lifetime of the annuitant (person buying the plan). If the annuitant dies, no death benefit is payable and the annuity payouts stop.
- Life Annuity with Return of Purchase Price
In this variant, annuity payouts are paid for the lifetime of the annuitant. When the annuitant dies, the annuity stops and the Purchase Price is returned to the nominee.
- Life annuity guaranteed for certain period and thereafter payable for life
This variant promises annuity payments for a specified guaranteed period. This period usually ranges from 5 years to 20 years in multiples of 5. If the annuitant dies during the guaranteed period, the annuity payments would continue for the guaranteed period and then stop. If the annuitant survives the guaranteed period, annuity would continue for the entire lifetime.
In this variant, the annuity payable increases every year by a specified percentage and is payable for life.
This annuity covers the life of the annuitant and his spouse. The annuity payouts continue till the survival of the annuitant and after that continues for the spouse’s lifetime as well. These annuities are also called last survivor annuities as the annuities continue till the lifetime of the last surviving member. These annuities can be issued in any of the above mentioned variants.
Deferred Annuity
Under these plans, the annuity payments are deferred or postponed till a specified tenure. The plans are bought for a specified tenure during which the policyholder is required to pay the premiums. The plan is designed to build a retirement corpus.
Deferred annuity plans can be offered as traditional plans or Unit Linked Insurance Plans, or ULIPs. While traditional plans promise a guaranteed return, ULIPs invest the premiums in the market enabling the investment to earn market-linked returns.
Premiums under the plan are payable for the chosen term of the plan or for a limited period depending on the plan features.
These plans have both maturity and death benefit. While the death benefit can be completely withdrawn by the nominee, the treatment of maturity benefit is different. The policyholder has three choices for the maturity benefit. 1/3rd of the benefit can be availed as lump sum while the remaining should be compulsorily used to avail annuity. The policyholder can, alternatively, use the entire proceeds to receive annuity. Lastly, the proceeds can also be invested in a Single Premium Deferred Annuity Plan wherein the annuity payments are postponed and start after a specified tenure.
Unlike other plans of insurance, premiums for pension plans are tax fee under Section 80CCC. Annuity payouts are taxable in the annuitant’s hands while the withdrawn part of the benefit (1/3rd part) is tax-free under Section 10(10A).
Opting for the right one
Immediate Annuity Plans are best suited to individuals who have retired or are about to retire. Since payouts would be required immediately, they should opt for these plans.
Deferred Annuity Plans are meant for individuals who are planning to build a retirement corpus and need payouts after 15-20 years. They can buy Deferred Annuity Plans, choose the term to coincide with their retirement age, and invest premiums regularly to build up a corpus.
On plan maturity, the accumulated funds can be used to receive annuity. Thus, both the plans have their individual applications and fit perfectly in any retirement planning stage an individual is in.
