Annuity
An insurance contract in which a corpus paid as a lump sum or in instalments buys a periodic payment from the insurer, at a rate fixed at purchase and guaranteed for life or the contracted term.
In plain language
An annuity is how a retirement corpus is turned back into a salary. You hand an insurance company a sum of money — the purchase price — and the insurer undertakes to pay you a fixed amount every month, quarter, half-year or year.
The person receiving the payments is the annuitant. The amount depends on the annuity rate at the time of purchase, and that rate is then guaranteed for the entire period. This is the one retirement product in the paper that removes the question "will the money last?" — the insurer, not the retiree, carries it.
The price of that certainty is steep: the workbook calls annuity returns very low, the costs high and opaque, and the decision final.
How it works
Two timings. In an immediate annuity payments start straight away, at the frequency chosen. In a deferred annuity the vesting age is some time away; the corpus is built in the deferment period and the annuity is bought at vesting-age rates. See deferred annuity.
The options the workbook lists (Chapter 4 and Chapter 6 give the same seven):
| Option | What it adds |
|---|---|
| Life, uniform rate | Nothing — the base case |
| 5/10/15/20 years certain, then for life | Payments continue for the certain period even if the annuitant dies |
| Life with return of purchase price | Purchase price goes back on death |
| Life increasing at a simple 3 per cent | The only option with any nominal step-up |
| Life with 50 per cent to spouse | Half the annuity continues to the spouse |
| Life with 100 per cent to spouse | Full annuity continues to the spouse |
| 100 per cent to spouse and return of purchase price on death of last survivor | Both |
What moves the rate. Add-on features (return of purchase price, spouse cover, inflation-adjusted payouts) lower the payout. A larger purchase amount is likely to get a better rate. Older annuitants get more, because payments are expected for fewer years. Women typically get less than men, because their life expectancy is higher. Poor health and lifestyle increase the payout. Rates generally follow market interest rates, and are reviewed periodically with IRDAI approval.
Tax. Annuity income is taxable in the annuitant's hands. Chapter 4 specifies that NPS annuity pension is taxed under the head "Salaries"; Chapter 6 says only that it is taxable as income.
A worked example
A 60-year-old buys a level life annuity with Rs 50,00,000. Take an annuity rate of 7 per cent purely as an illustration — the workbook gives no rate, and actual rates vary by provider and date.
Annual annuity = 50,00,000 × 7% = Rs 3,50,000
Monthly = 3,50,000 ÷ 12 ≈ Rs 29,167
The workbook's warning is about what that Rs 3,50,000 is worth later. At the 6 per cent inflation it uses in Chapter 3:
Price level after 20 years = (1.06)^20 = 3.2071
Real value at age 80 = 3,50,000 ÷ 3.2071 ≈ Rs 1,09,132
At 80 the same annuity buys less than a third of what it bought at 60.
Now the 3 per cent simple step-up, holding the starting payout at Rs 3,50,000 only to isolate the step-up (in reality the add-on would start lower):
After 20 increments = 3,50,000 × (1 + 20 × 0.03) = Rs 5,60,000
Needed to keep pace = 3,50,000 × 3.2071 ≈ Rs 11,22,487
The step-up closes less than a third of the gap. That is exactly the workbook's conclusion: size the annuity to cover essential, mandatory expenses and hedge the rest with growth assets.
Why NISM asks about it
Annuities run through the whole paper. Chapter 2, section 2.10.7, defines the contract; Chapter 4, section 4.2.3 (Pension from Annuity), lists the options and the factors that move annuity rates; Chapter 6, section 6.2.2, profiles the annuity as a distribution-stage product; and Chapter 7, section 7.3, sets out its pros and cons. Expect questions on which option carries a step-up, which features lower the payout, why women get lower rates, and whether an annuity can be surrendered or changed after purchase.
Common exam traps
- The rate is locked at purchase. Buying when interest rates are low locks in low income for life — Chapter 3, section 3.5.5, names this as a distinct risk and suggests staggering purchases.
- Once bought, it is final. Neither the option nor the provider can be changed, and the principal cannot be redeemed, unless the contract returns the purchase price.
- Only one listed option steps up, and only at a simple 3 per cent. Every other option is level and fully exposed to inflation.
- Add-ons cost payout. Return of purchase price and spouse cover reduce what the annuitant receives.
- Women get lower payouts, older annuitants and those in poor health get higher ones — all through life expectancy.
- "Guaranteed" is not "inflation-protected." The workbook lists both guaranteed income and inflation risk as features of the same product.
- Chapter 6 mentions surrender charges for fixed annuities while also saying the principal cannot be redeemed once bought. Answer from the question's framing: the product-profile point is that the annuity is final.
Check yourself
1.How should the annuity's share of the retirement income mix change as retirement progresses, and why?
- a)It should start high and fall, since annuity returns are low and erode with inflation
- b)It should start lower — just enough for essential needs — and increase into mid and late retirement, because fixed income products carry reinvestment uncertainty and older retirees are less able to manage fresh investments
- c)It should stay constant throughout, since the annuity is fixed for life
- d)The entire corpus should be annuitised at retirement to remove all uncertainty
Show the answer
Answer: (b) It should start lower — just enough for essential needs — and increase into mid and late retirement, because fixed income products carry reinvestment uncertainty and older retirees are less able to manage fresh investments
One way of dealing with it is to LINK THE ANNUITY'S CONTRIBUTION TO THE TOTAL INCOME MIX TO THE STAGE OF RETIREMENT. IN THE EARLY RETIREMENT YEARS, an annuity's contribution can be LOWER AND JUST ENOUGH TO MEET ESSENTIAL NEEDS, AND INCREASE AS THE INDIVIDUAL MOVES TO MID AND LATE RETIREMENT YEARS.
Two reasons are given. The financial one: other fixed income products provide such income only for a specific period... THE RETURN MAY CHANGE WHEN RE-INVESTED ON MATURITY, UNLIKE AN ANNUITY THAT IS FIXED FOR LIFE.
And a practical, human one that is easy to overlook: as retirement progresses, individuals may be UNABLE AND UNWILLING TO DEAL WITH THE UNCERTAINTY IN INCOME AND THE ADMINISTRATIVE ISSUES OF MAKING FRESH INVESTMENTS as the earlier investments mature.
Option (d) is a real error — the annuity's disadvantage is the lower returns and the loss of purchasing power over time due to the effects of inflation, so a portion of the corpus must still be earmarked for growth to counter inflation.
2.Once an annuity has been purchased, what can the annuitant change?
- a)The type of annuity, but not the provider
- b)Nothing — the principal can neither be redeemed nor can the type of annuity be changed
- c)Both the type and the provider, once a year
- d)The provider, but not the type of annuity
Show the answer
Answer: (b) Nothing — the principal can neither be redeemed nor can the type of annuity be changed
"THE ANNUITY ONCE PURCHASED IS FINAL, AND THE PRINCIPAL INVESTED CAN NEITHER BE REDEEMED NOR CAN A CHANGE BE MADE IN THE TYPE OF ANNUITY CHOSEN."
This is why the workbook is emphatic about comparing before buying: "THE RATES OF DIFFERENT PROVIDERS NEED TO BE COMPARED BEFORE BUYING AN ANNUITY." It is one of the few genuinely irreversible decisions in retirement planning.
What the annuitant CAN still choose is the payment mode: ⚠️ "MONTHLY, QUARTERLY, HALF-YEARLY OR ANNUAL."
The two risks the workbook names: ⚠️ "Fixed annuities suffer from HIGH SURRENDER CHARGES THAT CUT INTO ITS RETURNS. Plus, another disadvantage is that IT DOESN'T KEEP PACE WITH INFLATION. AS A RESULT, THE VALUE OF THE MONEY WILL DECLINE OVER TIME."
One compensating certainty: the annuity rate IS GUARANTEED FOR THE ENTIRE PERIOD, reviewed periodically with the approval of IRDAI.
3.Under the RMLEA, how does the loan-to-value ratio set by the National Housing Bank vary with age, and how is the annuity taxed?
- a)It falls from 75 percent at 60 to 60 percent at 80; the annuity is taxable
- b)It starts at 60 percent for ages 60 to 70 and rises to 75 percent for age 80 and above; the annuity is exempt from tax
- c)It is a flat 50 percent at all ages; the annuity is taxable as salary
- d)It depends only on property value, not age; the annuity is exempt
Show the answer
Answer: (b) It starts at 60 percent for ages 60 to 70 and rises to 75 percent for age 80 and above; the annuity is exempt from tax
"The operational guidelines of the NATIONAL HOUSING BANK (NHB) define the LOAN TO VALUE (LTV) RATIO to determine the quantum of loan. IT STARTS AT 60 PERCENT BETWEEN THE AGE OF 60 YEARS AND 70 YEARS AND GOES UP TO 75 PERCENT FOR AGE 80 YEARS AND ABOVE."
⚠️ The ladder rises with age, for the same reason annuity payouts rise with age — the lender expects fewer years of disbursement and less interest accrual before the property is realised.
Tax: ⚠️ "THE ANNUITY RECEIVED IS EXEMPT FROM TAX IN THE HANDS OF THE BORROWER." This is consistent with the plain RML, where all receipts are exempt from income tax under Schedule II of the Income-tax Act, 2025 (formerly section 10(43)) — because these are loan proceeds, not income.
What the RMLEA adds to a plain reverse mortgage: ⚠️ "The scheme ENSURES A LIFE TIME PAY-OUT to the senior citizens THROUGH AN ANNUITY BOUGHT FROM AN INSURANCE COMPANY USING THE REVERSE MORTGAGE LOAN AMOUNT." The lending institution assesses the property, disburses the loan and sources the annuity.
The borrower chooses between a lifetime annuity with or without return of purchase price, with an annuity cover for the spouse also provided.
Where this is taught
- Series X-A · Chapter 2: Time Value of Moneyintroduced here
- Series XVII · Chapter 2: Financial Markets & Investment Productsintroduced here
Related terms
- Inflation riskThe risk that the money an investment pays out will be worth less in goods and services than expected, because prices have risen — highest in fixed-return products and most damaging to retirees.
- CommutationTaking a portion of a pension or annuity corpus as a lump sum at retirement instead of as income — typically up to one-third in superannuation funds and insurers' pension plans.
- Deferred annuityAn annuity whose payments start at a vesting age some time after purchase, so the corpus is built or held in the deferment period and income is locked in for the later years of retirement.
- Longevity riskThe risk that a person outlives their retirement assets — living longer than the plan assumed, so the corpus runs out while income is still needed.
- National Pension SystemA PFRDA-regulated, defined-contribution retirement scheme in which the subscriber builds a market-linked corpus and must convert part of it into an annuity at exit; there is no guaranteed return.
- Annuity Service ProviderAn IRDAI-registered life insurance company empanelled by PFRDA to sell NPS subscribers the annuity they must buy on exit, and to pay the pension for the life of the contract.
- Ordinary annuityA series of equal payments falling at the end of each period — the default form of annuity, and the one every standard present value and EMI calculation assumes.
- Regular incomeOne of the two ways an investment pays you: a steady flow of money while you hold it, such as dividends on shares and fixed interest on debt. The other way is capital appreciation.
- Unified Pension SchemeAn option under the NPS for Central Government employees, effective 1 April 2025, that adds an assured payout of 50 percent of the last 12 months' average basic pay after 25 years of qualifying service.
- Atal Pension YojanaA government-guaranteed defined-pension scheme for unorganised-sector workers, paying a fixed Rs 1,000 to Rs 5,000 a month from age 60 for contributions started between ages 18 and 40.
- Reverse mortgageA loan that pays a senior citizen a periodic income against a pledge of the residential property they live in, repayable from the sale of that property after death or permanent departure.
- Present Value Annuity FactorThe number that converts a level stream of equal payments for n periods into its present value at rate r: PVA(n, r) = (1 − (1 + r)^−n) / r. Used with the PV factor to value bonds.
- Retirement Income SchemeThe NPS life-cycle scheme that holds the drawdown corpus during decumulation, cutting equity on a glide path from 35 per cent at 60 to 10 per cent at 75, while paying out through SPR or SUR up to age 85.
- Pradhan Mantri Vaya Vandana YojanaA closed Government of India pension scheme for those aged 60 and above, run by LIC, paying a guaranteed pension for 10 years and returning the purchase price at maturity; no new enrolment after 31 March 2023.
- Inflation Indexed BondsGovernment securities issued by the RBI whose fixed real coupon is applied to an inflation-adjusted principal, with the higher of face value and adjusted principal repaid at maturity.
- Purchasing powerWhat a sum of money can actually buy in goods and services. Inflation reduces it, so the same rupee amount buys less the further in the future it is received.
- Life expectancyThe average period a person is expected to live, based on birth and death statistics. In India it rose from 58 years in 1990 to 72 in 2024 — good news that creates longevity risk for retirement.
- Tier I accountThe mandatory NPS retirement account: restricted withdrawals, a 75% equity cap, tax benefits and compulsory annuity purchase with part of the corpus on exit.
- Reverse Mortgage Loan Enabled AnnuityAn extension of the reverse mortgage in which the lender uses the loan amount to buy a lifetime annuity from an insurer, so the senior citizen's income lasts for life rather than the loan tenure.
- Annuity finalityThe rule that once an annuity is bought, it is locked in for good — the principal cannot be redeemed and the type of annuity chosen cannot be changed.
- EEE tax regimeA tax treatment where contributions, returns and (largely) withdrawals are all exempt from tax — the category the NPS is described as falling under, though its exit stage carries some conditions.
- Staggering income investmentsBuying income-generating retirement products in tranches over time, instead of committing the whole retirement corpus at once, so a retiree is not locked into one interest-rate environment for life.
- Superannuation benefitAn employer-funded retirement scheme, on top of the mandatory PF, that pays one-third of the accumulated corpus as a lump sum and converts the rest into an annuity.
- Joint annuityAn annuity payout option under which the spouse continues to receive the annuity for lifetime after the death of the investor.
- LadderingBuying bonds or fixed deposits maturing at staggered dates rather than all in the same year, so that interest rate risk is spread and a maturity arrives every year to fund income.
- Future valueWhat a sum of money invested today will be worth at a future date once returns have been earned and reinvested — the compounding half of the time value of money.
- Annuity dueAn annuity whose payments fall at the beginning of each period rather than the end, which makes it worth more than an otherwise identical ordinary annuity.
- PerpetuityA constant cash flow received every period with no end date. Its present value is simply the cash flow divided by the discount rate: PV = C / r.