An annuity is a contract in which you hand over a lump sum and receive regular payments in return, often every month, for a set period or for life. It is one of the main ways retirement savings are turned into a pension-like income.
What it is
During your working years you build up a corpus, which simply means a pool of savings. Retirement schemes such as the National Pension System (NPS) are designed for this build-up phase. NPS Trust, the body whose official page is the source for this guide, describes NPS as a pension system, so it is a natural starting point for understanding where retirement money comes from.
An annuity is what happens at the next stage. Instead of leaving the whole corpus in your account and drawing it down on your own, you pay part or all of it to a provider, usually a life insurer. The provider then promises you an income according to the terms of the plan.
How it works
The basic mechanics are the same across most annuities:
- Purchase price: the lump sum you pay in.
- Payout: the amount you receive, monthly, quarterly, half-yearly or yearly, depending on the plan.
- Term: payments may run for your lifetime or for a fixed number of years.
- Return of purchase price: some plans return the original sum to a nominee after your death, others do not. Plans that return it generally pay a smaller regular amount.
- Single or joint life: a joint-life plan can continue paying a spouse after you.
The trade-off is simple. A longer or more generous promise, such as lifetime income with return of capital, usually means a lower starting payout than a basic plan. Once you buy, the terms are generally hard to change, so it helps to read them carefully first.
A simple illustration
Suppose, purely for illustration, you pay ₹10 lakh and the plan pays ₹5,000 a month. That is ₹60,000 a year, or 6% of the purchase price. Real plans quote their own rates, and these figures are not from any provider.
You can use the Compound Interest Calculator to see how a corpus might grow before you reach the stage of buying an annuity.
What it means for you
The case for an annuity is predictability. A regular income can cover household costs without you having to decide each month how much to withdraw. The case against is reduced flexibility: money paid for an annuity is generally not available as a lump sum later.
If you are weighing options, these are the things worth checking:
- Payout rate: compare the regular income quoted for the same purchase price across providers.
- Type of plan: life-long or fixed term, single or joint life, with or without return of purchase price.
- Inflation: a fixed payout buys less over time, so ask whether any plan offers increasing payments and what that costs in a lower starting amount.
- Tax treatment: ask how the income is taxed under the regime you follow, and confirm the current rule with the provider or a tax professional. You can estimate your own position with the Income Tax Calculator.
- Provider details: read the policy document, charges, and the provider’s claim and service record.
- Rest of your plan: consider other income, such as savings, rent or family support, and how much you want to keep accessible.
Rules on how much of an NPS corpus must go into an annuity, and the terms for doing so, are set by the pension regulator and can change. Check the current rules on the official NPS Trust and regulator pages before deciding, as this guide does not state specific percentages.
Common mistakes to avoid
- Buying the first plan offered without comparing payout rates.
- Ignoring what happens to the money after death, and whether a spouse is covered.
- Overlooking inflation when judging whether a fixed income will be enough in later years.
- Assuming all retirement savings need to go into one product, when rules and your needs may allow a mix.
- Skipping the policy document, especially the sections on exclusions and charges.
