Your financial life is divided into three unique segments – accumulation, preservation and distribution. The life of your investments also follows the same pattern. While you are professionally employed, you have an external source of income. In this period of life, you invest your savings to meet specific financial goals later in life.
One of these goals is to build a large retirement corpus that can help you sustain your life without having to work. After you have achieved this goal you can retire from active duty and spend your time at your convenience.
But you still need to invest your money such that you can receive a regular sum of money to look after your expenses. This is also the story of life insurance and annuity plans.
What is a Life Insurance Policy?
A life insurance policy is a legal financial instrument. The general picture you can have about life insurance is that you can secure your dependent’s future financially with a life insurance policy. The policy will provide large lump sum money to the dependents in the event of your early death.
You will need to pay a small amount every year to ensure coverage for your family. This amount is the premium of your life insurance policy.
However, life cover is not the only benefit of a life insurance plan. You can also invest your savings for a long-term goal into these plans. Life insurance is considered one of the safest long-term investments after government bonds and securities. Apart from this, life insurance investments are generally free from taxes.
Thus, life insurance plans provide coverage for your family from your early death and a venue for you to preserve and grow your wealth over a long time.
What is an Annuity Plan?
Annuity refers to an arrangement (esp financial) that ensures a regular payment of a sum to you from an investment. Annuity plans are the special instruments that enable you to turn your lump sum money into a regular income stream.
You can invest in annuity plans either in a lump sum or as a recurring deposit. However, regardless of your investment mode, after maturity annuity plans will start paying the regular income out of the saved amount.
Annuities are generally looked upon as an investment to safeguard your regular income post-retirement. The goal of annuity is to provide you with a long-term and steady income stream after you retire.
How does Annuity Plan Differ from a Life Insurance Plan?
Though both life insurance and annuity have some similarities and are long-term investments, they are not the same. While you buy life insurance to provide a safety net for your family in case of your untimely demise, annuity plans make sure that you don’t outlive the investments you have made.
Here’s the difference between life insurance and annuity
1. Purpose of the Investment
Life insurance makes sure that your family is financially secure even after you die by providing income to your dependents. Some variants of life insurance do provide additional benefits such as maturity benefits, income-earning options as well as the inclusion of riders such as critical care. But the main function is to provide the death benefit to those dependent on you
On the other hand, annuity plans provide income to you after you retire and live beyond the expected life. Thus its major function is retirement income. Thus you buy an annuity to provide yourself with income in case you outlive your savings.
2. Modes of Benefit Payment
The payout in life insurance and annuity affect you and your beneficiary differently.
In the case of life insurance policies, the payout is the death benefit. It is the pre-decided amount that your beneficiary will get only after your death. Your beneficiaries will get the sum assured in your policy in case you die during the policy. This amount is usually in a lump sum which can be used to cover expenses of education, pay off debt, etc
The case is different in terms of the annuity. Here you receive your payout while you are alive. This payout is in the form of regular income. Though some annuities do have death benefits as well.
3. Type of Plans
Life insurance is of the following types:
a. Term Life Insurance
A term life insurance plan provides you life coverage for a specific period or term which can be 10, 20, or 30 years. If you die within the policy term, then a death benefit is provided to your beneficiaries.
b. Whole Life Insurance
This type of insurance provides you life coverage for your whole life, as long as you pay the premiums.
c. Unit Linked Insurance Plans (ULIPs)
These are a type of life insurance product that provides the dual benefits of insurance as well as investment in a single product. Under this, you are provided with an opportunity to invest money in a fund option you prefer as well as a life cover.
d. Endowment & Money Back Plans
Endowment and money back plans are safe long-term investment life insurance plans. These plans are great for preserving wealth over a long period. These plans are one of the safest investments and provide tax benefits on invested and maturity amounts.
Different types of Annuity plans are as follows:
a. Deferred Annuity
These are the types of annuities in which the income to be received is deferred to a later date after the premiums are paid. That is, the insurance company agrees to pay your amount to you at a future date. The minimum period is 1 year.
b. Immediate Annuity
Under this type, you make a one-time contribution to your annuity. The premium is paid in a lump sum. This lump sum is contributed to a regular income stream at the time of payout. Here the payment starts almost immediately rather than at a future date.
c. Fixed Annuity
Type of annuity contract in which the insurer promises to pay the buyer a fixed, specific interest rate on the contribution made. That is, the payout remains constant throughout the payment period. This ensures that the income remains steady as the resources are put into fixed income instruments.
d. Variable Annuity
Here the interest guaranteed by the insurer can change based on the investment performance you have put your resources into. The resources here are connected to the market and thus fluctuate.
4. Tax Treatment
Both life insurance and annuity are tax-deferred instruments. Both allow deductions from tax but are subject to conditions. However, if you follow the rules life insurance plans are tax-free both at the time of investment and maturity.
On the other hand, an annuity plan with a lump sum investment has a taxable payout. Regular payments from annuity plans are taxable as salary income.
5. Age Group in which these are Purchased
Since both life insurance and annuity cater to different groups, the ages when these are purchased also differs.
Life insurance plans are generally bought at an earlier stage of life usually when you are in your mid-twenties.
Annuity, though advised to start early, is generally purchased by people who are above 40 or even are close to retiring.
When to Start an Annuity?
Annuities have two phases – investment and distribution. You can start an investment as soon as possible. However, you want higher growth during the investment period. Thus, investing in plans like Invest 4G is better as it gives you the option to invest aggressively.
In the distribution period, you want your accumulated corpus to remain safe. Thus, you invest only in the safest options. Although Invest 4G allows you to keep the money in safe debt funds, you have many other options as well.
For example, if you have received a large lump sum amount from a provident fund etc. you can invest in these plans. The correct age to start this phase of annuity is when you decide to give up your external source of income; i.e., your employment.