a. a fixed amount of money,
b. periodically, say every month,
c. for the rest of your life.
It is this comfort of receiving income every month, month after month, for one's entire lifetime that attracts people towards annuity plans.
You don't have to worry about whether your savings will last your lifetime or not. You are assured of receiving a fixed sum till the very end of your (or even your spouse's) life.
If you have invested in a Pension Plan, then you have to compulsorily buy an Annuity Plan at retirement, from the amount accumulated in your Pension Plan. But, if you don't have a Pension Plan, you have the option to even buy an Immediate Annuity Plan that will start your annuity payments without any waiting period.
However, beware!
While the concept of annuity sounds good, it comes with some 'very serious' drawbacks. And it is these drawbacks that make me dislike annuities.
1. Withdrawals are completely prohibited
Once you buy an annuity, you lose access to your principal amount. If any need for lump sum money arises, you cannot depend on the annuity plans to bail you out. Such plans do not allow premature withdrawal at all.
My contention — why have no flexibility to restructure my investments, if required, due to any change(s) in my financial circumstances.
2. Same returns forever
The returns, once fixed at the time when you buy the plan, do not change throughout the lifetime. You (your spouse) will earn the same returns year after year for probably decades.
My contention — why to lose the opportunity to earn higher returns in case they move up in the future (Of course, in an annuity plan your income is protected at the same levels, even if the market interest rates go down in the future).
3. Comparatively lower returns
A typical annuity plan pays 1-2% lower interest than a comparable product like bank FD, post-office deposit or debt mutual funds.
My contention — why settle for a lower payout? Even a tiny bit of active portfolio management will help you earn much more money than staying invested with the totally passive annuity plan.
4. Annuity income is taxable
Besides, you have to pay tax on the income that you receive from an annuity plan. There are no tax breaks on the pension income from annuities.
My contention — I could always invest in the more tax-efficient investments available from time to time, instead of having a lifetime of association with the hugely 'tax-inefficient' annuity plans.
5. No protection against inflation
And of course, after a few years, this fixed inflow will mean nothing. Inflation would have made everything too expensive. So the fixed amount that I get every year, will prove to be insufficient to meet my expenses after some years.
My contention — I have to make investments that protect me against inflation too.
Concluding: All in all, getting stuck — forever — with a plan which is rigid; and offers poor and tax-inefficient returns, doesn't appear to be a great idea... especially when you can do a much better job yourself without any serious efforts or requiring any serious financial knowledge.
