Immediate annuity
Also written Immediate annuity plan
An annuity whose payments begin soon after it is bought — generally within 12 months — usually purchased with a single lump-sum premium at retirement.
In plain language
An annuity is a stream of payments for life or for a pre-defined period. Under an annuity contract, which is a life insurance policy, the insurer agrees to pay the purchaser — the annuitant — a series of regular payments. Its main objective is to counter longevity risk and, to some extent, inflation.
There are two basic types. A deferred annuity begins more than 12 months after purchase and is generally bought during working years. An immediate annuity begins almost at once — generally within 12 months of purchase.
Most immediate annuities are bought with a single premium: a lump sum paid at retirement, converted into a guaranteed income that starts straight away. That makes them one of the distribution-stage products, where income, low risk to principal and protection of capital matter most.
How it works
The rate is locked. The annuity paid depends on the annuity rate at the time of purchase, and that rate is guaranteed for the entire period. Insurers review annuity rates periodically with IRDAI approval — which matters only for new purchases.
Payment frequency is typically monthly or annual, with quarterly and half-yearly also available.
Payout options, chosen at the vesting age:
| Option | What happens | Annuity amount |
|---|---|---|
| Life, without return of purchase price | Paid for life, stops on death; insurer keeps the purchase price | Highest |
| Life, with return of purchase price | Paid for life; purchase price returned to the nominee on death | Lowest |
| Guaranteed for a certain period | Paid for a defined period, say 10 or 20 years, whether or not the annuitant survives; after that, only while the annuitant lives | In between |
| Joint annuity | Spouse continues to receive the annuity for life after the annuitant's death | — |
Insurers also offer inflation-adjusted and fixed-increasing annuities.
Tax. Unlike life insurance policies, annuities do not enjoy tax-exempt status: annuity income is taxed in the hands of the annuitant. The workbook states that the premium paid is eligible under Section 80C within the overall limit; its deductions table (Table 7.5) shows 80C is not available under the new tax regime.
In employer schemes. Employers may buy an immediate annuity from a life insurer with a lump sum for one or a few employees; in approved superannuation schemes, the corpus after commutation is used to purchase an annuity.
A worked example
Illustrative figures — annuity rates are assumptions, not quotes.
Mr and Mrs Pillai, both 60, put Rs 50,00,000 into an immediate annuity at retirement. Suppose the insurer's rates are:
| Option | Assumed rate | Annual annuity | Monthly |
|---|---|---|---|
| Life, without return of purchase price | 7.5% | Rs 3,75,000 | Rs 31,250 |
| Life, with return of purchase price | 6.5% | Rs 3,25,000 | Rs 27,083 |
The trade-off is Rs 50,000 a year. With return of purchase price, the Pillais give up Rs 50,000 of income every year in exchange for Rs 50 lakh going to their nominee. Over 20 years that is Rs 10 lakh of income forgone to leave Rs 50 lakh behind.
The survivor question. If Mr Pillai dies at 68 on a single-life option, the income stops — or, with return of purchase price, Rs 50 lakh goes to the nominee but the monthly cheque ends. A joint annuity keeps paying Mrs Pillai for her lifetime, at a lower starting amount.
Tax. In a 20% slab, before cess, the Rs 3,75,000 a year is not Rs 3,75,000 of spending money; the annuity is taxable income. An adviser comparing it with a systematic withdrawal plan from a mutual fund must compare after-tax income — and weigh that the annuity rate is guaranteed for life while the SWP depletes units.
Why NISM asks about it
Chapter 5 (Retirement Products), section 5.3.1 — Annuity from insurance companies — among the distribution-stage products, with systematic withdrawal plans at 5.3.2; Chapter 4 mentions employers buying immediate annuities for superannuation. Expect questions on deferred versus immediate annuity (the 12-month dividing line), which payout option gives the highest and lowest annuity, and the tax treatment of annuity income.
Common exam traps
- Immediate: payments begin within 12 months. Deferred: more than 12 months after purchase.
- Without return of purchase price pays the highest annuity; with return of purchase price pays the lowest.
- The annuity rate is fixed at purchase for the whole period. Later rate reviews do not change an existing annuity.
- Annuity income is taxable, unlike life insurance proceeds.
- Guaranteed-period annuities pay for the guaranteed years even if the annuitant dies; beyond that, only while the annuitant is alive.
- A joint annuity continues to the spouse for life.
Check yourself
1.Chopra Textiles wishes to reward two long-serving employees with superannuation benefits by paying a lump sum contribution out of current revenue to buy an immediate annuity for each of them from a life insurance company. How does the workbook classify this arrangement?
- a)As one of the methods of payment by the employer
- b)As funding through a superannuation trust
- c)As the unfunded method of paying pensions out of current revenue as and when due, which is not allowed
- d)As an approved superannuation fund under Part B of the Fourth Schedule
Show the answer
Answer: (a) As one of the methods of payment by the employer
The workbook lists this under 4.5.1 Payment by the employer: "(a) There are occasions when an employer decides to arrange for superannuation benefits for one or a few employees as reward for their dedicated services by paying a lump sum contribution out of the current revenue to buy an immediate annuity from a life insurance company."
The employer has two arrangements open to it: "(1) Payment by the employer; and (2) Funding through a trust."
Option B is wrong — under a trust "The employer should create a Trust for funding the pension liability and appoint Trustees", the trust must be "irrevocable and should be distinct from the employer", and contributions are transferred to the Trust Fund. Chopra Textiles has created no trust.
Option C is wrong — that is sub-method (b), where the employer "has not created any fund for it and wishes to pay himself the pensionary benefits ... out of the current revenue" as and when due. The workbook says of that method "this method is not allowed". The difference is that in (a) the lump sum buys an annuity from a life insurer, so the pension does not depend on the employer's future profits.
Option D is wrong — an approved fund requires an irrevocable trust approved by the Commissioner of Income Tax; a one-off annuity purchase for two employees is not such a fund.
Background rule: all establishments other than those specifically allowed "are required to arrange annuities through Life Insurance Corporation of India or any other IRDAI approved life insurance companies."
Where this is taught
Free preparation for NISM Series X-BRelated terms
- Systematic Withdrawal PlanA standing instruction to redeem a set amount — or only the appreciation — from a mutual fund scheme at a chosen frequency, used to manufacture a regular income in retirement.
- 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.
- Distribution stageThe retired years, in which the corpus built during working life is converted into periodic income — the stage where protecting capital matters more than growing it, because it can no longer be topped up.
- Joint annuityAn annuity payout option under which the spouse continues to receive the annuity for lifetime after the death of the investor.
- 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.
- SuperannuationAn organisational pension programme set up by an employer for its employees, funded through an irrevocable trust or a life insurer, typically paying annuities on retirement.
- Capital protectionThe requirement, once income generation begins in retirement, that a product not put the underlying principal at risk in the pursuit of income — one of the two evaluation criteria the workbook sets for the retired phase.
- NPS final withdrawalPFRDA's exit rules for closing an NPS account: a mandatory minimum annuitisation, small-corpus exceptions letting the whole balance be withdrawn, and a tax exemption of up to 60% of the corpus.
- Partially inflation-linked pensionA pension that adjusts to inflation only in part, as in the workbook's Case 4, where the pension rises by just 50% of inflation, leaving a shortfall the retiree must fund from other savings.
- 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.