After decades of accumulating a retirement corpus, a new question arrives: how do you turn a lump sum into a monthly income that never runs out? An annuity is the financial product built for exactly that job. You hand an insurer a lump sum – or build one up over years – and in return the insurer pays you a fixed sum every month or year for the rest of your life, or for a fixed term. It is the closest thing finance offers to a private pension. Here is how annuities work, the choices you face when buying one, and what they cost in returns and flexibility.

Immediate vs deferred annuities

The first choice is timing. In an immediate annuity, you pay a single lump sum – the purchase price – and the payouts begin almost at once, typically within a month or a year. This is the classic retirement move: at 60, you convert part of your corpus into a guaranteed monthly pension. In a deferred annuity, you pay premiums over years (or a lump sum now) and the payouts begin at a chosen future date – the accumulation phase lets the money grow before the pension phase starts. India’s National Pension System, for instance, requires you to use at least 40 per cent of your maturity corpus to buy an annuity from a life insurer, which is a deferred-to-immediate conversion at retirement. Deferred annuities suit people still building their corpus; immediate annuities suit people already at the finish line.

The payout options: and the trade-offs between them

Insurers offer a menu of annuity options, and the choice shapes both your monthly cheque and what your family gets after you. The main variants:

• Life annuity: pays for as long as you live, then stops. Highest monthly payout, but nothing returns to heirs.
• Annuity with return of purchase price: pays slightly less each month, but your nominee gets the original lump sum back after your death. The most popular option in India.
• Joint-life annuity: continues paying your spouse after you, usually at the same or a reduced rate – essential if the pension must support two people.
• Annuity certain: pays for a fixed term, say 10 or 20 years, regardless of survival – useful for bridging a known gap.
• Increasing annuity: payouts rise each year, typically by 3 per cent, to offset inflation – at the cost of a lower starting pension.

Every added feature – return of capital, spouse cover, inflation linkage – reduces the monthly payout. There is no free lunch; you are buying certainties, and each certainty has a price.

How insurers price an annuity – and why rates move

An annuity rate is essentially the insurer’s answer to a bet on interest rates and your lifespan. The insurer invests your purchase price in long-term bonds and government securities, keeps a margin, and pays you from the yield. When bond yields are high, annuity rates are generous – recently, a 60-year-old buying a life annuity with return of purchase price could get around 7 to 8 per cent a year on the invested sum. When yields fall, so do annuity rates. Age matters too: the older you are at purchase, the higher the monthly payout, because the insurer expects fewer years of payments. This creates a genuine dilemma – buy early for certainty, or wait for a higher rate later. Most planners suggest annuitising in stages rather than all at once.

The tax treatment of pension income

Annuity payouts are taxed as income from other sources at your slab rate – there is no special exemption for pension income from annuities. The purchase itself has mixed treatment: premiums paid toward deferred annuities may qualify for deduction under Section 80CCC up to 1.5 lakh rupees a year, but the pension received is fully taxable. This asymmetry surprises many buyers – the taxman gives with one hand at contribution and takes with the other at payout. Factor the post-tax pension, not the headline rate, into your planning.

When an annuity makes sense – and when it does not

Annuities solve one specific problem: longevity risk, the fear of outliving your money. For a retiree with no other guaranteed income beyond a modest pension, converting a portion of the corpus – often a third to half – into an annuity buys sleep-at-night certainty for essential expenses. But annuities are poor wealth creators: the returns roughly track bond yields, the money is locked in for life, and most options offer no inflation protection unless you pay for it. The balanced approach most advisers recommend is a barbell – annuity income to cover non-negotiable monthly expenses, and the rest of the corpus in growth assets for inflation-beating returns and emergencies.

FAQs

Can I exit an annuity after buying it?

Generally no. Annuities are irreversible contracts – that permanence is what lets the insurer guarantee lifetime payments. Some deferred plans allow surrender with penalties, but immediate annuities cannot be cashed out.

What happens to the money if I die early?

It depends on the option chosen. With return-of-purchase-price, your nominee gets the lump sum back. With a plain life annuity, payments simply stop and the insurer keeps the balance.

Is the NPS annuity mandatory?

At NPS maturity, at least 40 per cent of the corpus must be used to buy an annuity from an empanelled insurer if you want to withdraw the rest tax-efficiently; using less is possible but the lump sum withdrawal becomes restricted.

Compiled by the Khabar 24h Editorial Desk from publicly available sources.