Immediate Annuity Vs Deferred Annuity

Table of Content

1. What Is an Annuity?

2. What Is an Immediate Annuity?

3. What Is a Deferred Annuity?

4. Difference Between Immediate Annuity and Deferred Annuity

5. Tax Benefits of Buying Annuity Plans

6. Which Annuity Plan Should You Choose?

7. Fees for Annuity Plans

8. Key Factors to Consider When Buying an Annuity

9. Common Mistakes to Avoid When Choosing an Annuity Plan

10. Summary

11. FAQs on Immediate Annuity Vs Deferred Annuity

What Is an Annuity?

An annuity is a financial product designed to provide a steady stream of income, often used for retirement planning. You invest a lump sum or pay in installments, and in return, the insurance company promises regular payouts, that is, either immediately or at a future date. 

There are different types of annuities, including fixed, variable, immediate, and deferred, each offering different benefits depending on your financial goals. 

There are two phases of annuity:

1. During the accumulation phase, the investor begins to build the cash value of the annuity.

2. The distribution phase is when the policyholder receives the benefits of the plan. 

Let us explore these types in the sections ahead to help you make an informed choice.

What Is an Immediate Annuity?

An immediate annuity is a type of annuity plan where a lump sum amount is paid out to an insurance company. In return, the insurance company provides guaranteed payouts to the insured individual almost immediately. From the issuance of the policy, the policyholder can receive the income from as early as one month, considering the annuity frequency (quarterly, monthly, annually, semi-annually) as chosen in the contract.

There is no accumulation stage in an immediate annuity plan. Upon purchasing the plan with a lump sum investment, the vesting stage begins immediately. This makes an immediate annuity the ideal choice for investing in retirement at a late stage.

What Is a Deferred Annuity?

A deferred annuity, unlike an immediate annuity, doesn't pay you immediately. This plan is designed specifically for long-term savings. The main advantage of deferred annuity is this plan lets you invest regularly, letting you accumulate a substantial sum of money. Furthermore, you can make withdrawals during times of need and gain tax benefits¹ on both your investments and withdrawals.

The charges you pay to the insurance company usually take the form of withdrawal charges, penalty taxes, income taxes, and surrender charges. Annual fees are, however, an important part of deferred annuities. The assets in the annuity plan are charged as rider and sub-account management fees. Thus, it's essential to go through all relevant details before making any decision about investing in a deferred annuity plan.

Difference Between Immediate Annuity and Deferred Annuity

Immediate and deferred annuity plans vary in significant ways. Let’s explore the difference between immediate annuity and deferred annuity in detail:

Tax Benefits of Buying Annuity Plans

Now that we know immediate annuity vs deferred annuity, let us look at the tax benefits. Understanding how annuities are taxed in India is essential before investing. Under the Income Tax Act, 19611, income from annuities is considered ‘income from other sources’ and taxable. 

• Deferred Annuity Tax Deduction under Section 80C of the Income Tax Act, 1961

Under Section 80C(ii) of the Income Tax Act, 1961 tax benefits are available for contributions made towards a deferred annuity plan, such as pension plans from insurers. Similarly, under Section 80C(xii), investments in Notified Pension Funds are eligible for deduction up to overall ceiling limit of ₹1,50,000, since they involve regular contributions during the accumulation phase.

• Deductions under Section 80CCC for Pension Contributions

In the case of an immediate annuity plan, where a lump sum is paid upfront and annuity starts instantly, the purchase amount does not qualify for deduction under Section 80C, but premiums contributed are eligible for deductions under Section 80CCC1 of the Income Tax Act, 1961, providing deduction upto maximum of Rs 1,50,000. 

• Deduction under Section 80CCD(1)

Section 80CCD(1) allows a deduction for Contributions made to Pension Scheme of Central Government / National Pension Scheme (NPS) by salaried employees or other individuals, subject to the prescribed limit. In addition, Section 80CCD(1B) provides an extra deduction of ₹50,000 for contributions beyond those covered under Section 80CCD(1). Thus, a taxpayer can claim a total tax benefit of up to ₹2,00,000.

However, you will get a combined deduction of Rs. 1.5 Lakh under sections 80C, 80CCC and 80CCD(1) as specified under Section 80CCE. Such deductions lower your total taxable income during your working years, helping you to save tax.

At the time of payouts, in both contexts, immediate annuity and deferred annuity, the income amount becomes taxable. However, if the total income crosses the basic exemption limit of ₹1.5 Lakh, then only tax deduction at source (TDS) is applicable.

The following are the tax benefits of buying annuity plans:

1. Under Sections 80C, 80CCC and 80CCD1 of the Income Tax Act, 1961, annuity policy contributions   are tax-deductible up to ₹1.5 Lakh annually. 

2. In deferred annuities, the annuitant's investment grows in a tax-free manner until the commencement of payouts. This is called tax-deferred growth.  

3. Under section 80CCC of the Income Tax Act, 1961, the premiums paid in immediate annuities are tax-deductible.

Which Annuity Plan Should You Choose?

It is normal to experience conflict when choosing an annuity plan due to the availability of numerous types. In addition, each type of annuity comes with a unique set of benefits. 

The following are key factors you need to consider when choosing an immediate or a deferred annuity plan: 

1. Age and Retirement Timeline

The annuitant’s age and retirement timeline indicate how much saving is required. For example, when you are nearing your retirement, opting for an immediate annuity is more beneficial compared to a deferred annuity since you have an idea of the amount of the retirement corpus. 

In contrast, when you are younger, investing in a deferred annuity is a good idea since you get sufficient time to grow your wealth in the accumulation phase. 

2. Income Needs (Immediate vs. Future)

The timing of the annuity purchase also matters a lot. For example, those who are nearing retirement have an idea of their probable retirement corpus, since they know how much they will be able to earn within that time frame. Depending on that, they can calculate the retirement income. In such a context, investing in an immediate annuity is most suitable. 

On the other hand, those who still have 20 or 30 years left to retire have the potential to grow in their career. Not only that, they have more to take risks and gain returns. In such circumstances, choosing a deferred annuity is right. 

3. Risk Tolerance

Considering risk tolerance is another significant factor at the time of purchasing an annuity. Since each type of annuity comes with different levels of risk, you need to identify your personal risk tolerance while choosing the right type. 

For example, the predictability and stability of fixed annuities make these perfect for conservative investors. Whereas, those with a higher risk appetite expect higher returns too. So, for them, choosing variable annuities is most applicable since they have larger market exposure. 

4. Tax Implications

Being aware of tax implications while purchasing annuities offers individuals the opportunity to opt for a plan that has the maximum tax benefits. For example, under Section 80C, contributions to notified pension funds and deferred annuity plans qualify for deduction up to ₹1.5 lakh, also under Section 80CCC, individuals who own immediate annuity plans  can apply for tax deductions for the premiums paid. Collectively, under Section 80CCE, deductions available under Sections 80C, 80CCC, and 80CCD(1) are capped at ₹1.5 lakh, while Section 80CCD(1B) extends the benefit, enabling a taxpayer to claim up to ₹2 lakh in total deductions. 

From the perspective of taxation, the treatment of annuity depends on the stage of annuity:

• Surrender Value – If a deferred annuity policy is surrendered before maturity, the surrender value received is taxable as income under Section 80CCC(2) in the year of receipt. Further, the deductions previously claimed under Section 80C/80CCC/80CCD become taxable if the policy is prematurely terminated.

• Vesting/Maturity – Pension policies are subjected to commutation as per the IRDAI Guidelines accordingly specific lumpsum amount gets commuted on maturity and for remaining amount the policy holder needs to mandatorily buy an annuity plan. Any payment received in commutation of pension as a lump sum on vesting (maturity) is exempt under section 10(10A)(iii) of the Income-tax Act, 1961, subject to fulfillment of various conditions under the current income-tax law.

• Regular Payouts – All the regular payouts are taxable under the head “Income from Other Sources” as per individual’s applicable tax slab rate.

According to the new tax regime of FY 2025-26, individuals earning ₹12 Lakh to ₹16 Lakh annually fall under the 15% tax slab. If you own a deferred annuity plan and you invest ₹50K towards it, you can ensure tax-deferred growth from your investments until the payout starts.

5. Desire for Guaranteed Income vs. Growth Potential

Aim for your objective behind the investment. Having clarity regarding whether you prefer guaranteed income that might offer you stability or growth potential, so your money can grow in the future, is crucial. 

If you are looking for stability during your retirement so you can be confident enough to take care of your requirements independently, then choose an immediate annuity. However, if you want the thrill of having higher returns from your investments, then investing early in a deferred annuity could be a smart choice.  

6. Health and Life Expectancy

Based on your health condition and life expectancy, the insurer finalises the annuity benefits. For example, people who opt for annuity investments early in their lives might benefit more from a life annuity. Contrastingly, those who suffer from health conditions can choose shorter payouts or return on investment features.

Note: While these guidelines offer a solid foundation, annuity planning is highly personal. You can consult our financial advisor at HDFC Life to select a plan tailored to your financial goals, lifestyle, and future needs.

Fees for Annuity Plans

Before investing in an annuity plan, it is essential to understand the fees involved. While some annuities have minimal charges, others, especially market-linked ones, may involve multiple cost layers that can impact your returns over time.

1. Policy Administration fee

This fee is levied by your insurer to cover the management and service costs provided to you throughout the annuity policy term. It includes the issuance, record keeping, compliance and customer services. 

2. Surrender Charges

When you decide to exit an annuity plan, this fee is applied by the insurer before the end of the contract. These charges work as a penalty for early withdrawal.  

3. Fund Management Charges

To manage your investment portfolios, the insurer charges a certain amount. These charges compensate the insurer for actively investing and managing your funds. Usually, these charges are applicable annually. 

4. Mortality or Rider Charges

Whereas immediate annuities do not have any mortality charges applicable, deferred annuities do. These are the extra amounts you need to pay in order to extend life cover during the accumulation phase. 

5. GST & Other Taxes 

For immediate annuity and deferred annuity, you need to pay 1.8% GST on the purchase prices. These charges are paid upfront at the time of purchase. 

Disclaimer: Keep in mind that the fund management, surrender and policy administration charges vary from one insurer to another. Please contact your insurer to have clarity on the applicable prices. In addition, review the product brochure and policy terms carefully. 

Now, let us look at how these charges are applicable in an immediate annuity and deferred annuity: 

Key Factors to Consider When Buying an Annuity

If you are not sure about  immediate annuity and deferred annuity and want to know which factors to consider while making the final call, here is a guide: 

1. Expected Returns

Think about the factor of expected returns while choosing between an immediate and deferred annuity. Even though it primarily depends on the type of investment strategy and interest rates, factors like whether or not the annuity is fixed or market-linked matter as well.

For example, fixed annuities provide guaranteed payouts with lower but guaranteed returns, while returns fluctuate in the case of market-linked or variable annuities. 

So, if you invest ₹20 Lakh in a fixed annuity for 6% annual interest, you might receive around ₹1,20,000 annually with a guaranteed source of income₹10,000 monthly. However, if you choose to invest in a market-linked annuity that is tied to the Nifty 50, you can expect a return ranging from 4% to 10%. 

2. Contribution Period

The contribution period is the period you devote to an annuity plan before starting to get the payouts. Compared to immediate annuities, the contribution period is more significant in deferred annuities. 

For example, a 35-year-old man starts to invest in a deferred annuity with an investment of ₹1,20,000 per year for 20 years. When he reaches his retirement age, he gets a regular stream of income for the rest of his life. Meaning, he gets the opportunity to build a retirement corpus in those 20 years.  

3. Flexibility

Flexibility is a quality that is not common in all types of annuities. Flexibility refers to the ability to withdraw or switch funds. It is better to choose a plan with more flexibility because that will give you the liberty to grow your funds with more investments in the future.

For example, whereas the traditional immediate annuities do not allow annuitants to withdraw before annuitisation, systematic plans do so during the post-vesting stage.  

4. Tax Implications

The tax implications of annuities vary depending on the type and stage of the annuity, whether immediate or deferred. Under Section 80CCC1, the premium paid towards both types of annuity plans is tax-deductible up to ₹1.5 Lakh. Collectively, under Section 80CCE, deductions available under Sections 80C, 80CCC, and 80CCD(1) are capped at ₹1.5 lakh, while Section 80CCD(1B) extends the benefit, enabling a taxpayer to claim up to ₹2 lakh in total deductions. 

Furthermore, if the annuity payout amount exceeds the exclusion ratio, it is taxable. The exclusion ratio refers to the initial investment amount towards the annuity plan. 

For example, if you are receiving ₹30,000 from your annuity, and you fall under the tax slab of 20%, you will be paying approximately ₹6000 as tax.  

5. Optional benefits

The riders or add-ons^* in annuity plans are a great way to extend the annuity benefits. The following riders are proven to be quite effective: 

• Inflation-indexed returns: Increase annuity income along with the rising prices over time. 

• Joint Life annuity: Protects both the annuitant and their spouses

• Life annuity with Return of purchase price: During deferment, 6% per annum compounded till death. 

For example, if an individual wants their family to receive the annuity amount after their death, they can choose a life annuity with a return of purchase price rider. This will help the nominee to receive the rest of the unpaid annuity amount. 

Common Mistakes to Avoid When Choosing an Annuity Plan

Making the right annuity choice is crucial for long-term financial security. Here are some common mistakes to watch out for:

1. Choosing the wrong payout frequency

Choosing the frequency of the annuity income depends on the annuitant's own requirements. Therefore, annuity payouts can be chosen on a monthly, quarterly, half-yearly or annual basis. Some prefer a lump sum payout in one go, while others, on the other hand, prefer monthly payouts similar to a pension.  

If you choose the payout frequency correctly, the purpose of owning an annuity can be served. Wrong payout frequency can disrupt your financial goals.  

2. Ignoring inflation (especially with an immediate annuity)

Many people ignore the factor of inflation while purchasing an annuity plan. As the purchasing power gets reduced over time, the value of the annuity drops. Especially, while purchasing an immediate annuity, this kind of mistake reoccurs.

Therefore, taking into account the inflation factor is crucial to add more value to your investment.

3. Not considering joint life cover.

Sometimes annuitants miss out on considering their dependents’ financial security. As a result, their single life cover stops at the time of the annuitant’s demise. Purchasing a joint life cover continues to protect the dependents' finances even after the annuitant's death. 

4. Choosing a deferred annuity too close to retirement

Deferred annuity is best to buy in your mid-20s and 30s, when you have plenty of time until retirement. It allows your investments to grow substantially by the time of your retirement.

However, if you choose a deferred annuity in your 50s, your investment will not grow as much. During this time, choosing an immediate annuity can assure a stable income. 

5. Underestimating post-retirement income needs

The best way to choose an annuity is to have a clear budget. Many people ignore this part. As a result, when they retire, they find out that the annuity payouts they have opted for are not sufficient. 

Therefore, it is essential to consider post-retirement income needs. For example, besides daily essentials, you need to consider medical expenses, emergency funds, and occasional luxuries.

Summary

Now that you have a clear understanding of immediate annuity vs deferred annuity, it will not be difficult for you to choose. Both these plans have perks when it comes to securing your retirement; you only need to align the most relevant one with your financial goal. If you have time until your retirement and have a higher risk appetite, choose deferred annuity insurance. 

However, if you are nearing retirement, aware of your regular expenses, and want to have a financially independent retirement, then an immediate annuity insurance is for you. 

Note: If assessee has opted for Old tax regime, assessee shall be eligible to claim deduction under chapter VI-A of the Income Tax Act, 1961 (like Sections 80C, 80D, 80CCC, etc). If assessee has opted for New tax regime, assessee shall be eligible to claim only a few deductions under Chapter VI-A of the income tax Act, 1961 (such as 80JJAA, 80CCD(2), 80CCH(2)). 

Reference Links

https://www.hdfclife.com/retirement-and-pension-plans/immediate-annuity-vs-deferred-annuity?srsltid=AfmBOorbnqc2ZFARxz_B6f8MZpV8UQnN-9ZeT4NYHBc2yzKfz_ceFNcN

FAQs on Immediate Annuity Vs Deferred Annuity

1. What is the primary difference between an immediate annuity and a deferred annuity?

The primary difference between immediate annuity and deferred annuity is based on the time frame when you start receiving the amount. In an immediate annuity plan, you receive a payout immediately once you complete investing. However, in a deferred annuity plan, you receive a payout after the deferred period.

2. What factors should individuals consider when deciding between immediate and deferred annuities?

While deciding between immediate and deferred annuities, the factors necessary to consider for every individual include financial needs post retirement, time left till retirement, savings portfolio, alternate investment options, and the impact of inflation on ROI and your investment plan.

3. How does the payout structure vary between immediate and deferred annuities?

For an immediate annuity, investors receive a payout immediately, while for a deferred annuity, the payout takes place after quite a long time. Thus, if you are not in a hurry to receive a payout post-retirement, go for a deferred annuity.

4. What are the advantages of opting for a deferred annuity for retirement planning?

By opting for a deferred annuity, you can maintain a basic standard of living during retirement years. Alongside, a deferred annuity provides you and your family members with financial stability and security as well as comprehensive coverage for any unforeseen and unfortunate expenses. This will thereby help to experience a relaxed life post-retirement.

5. What are the three types of annuities?

The three main types of annuities are fixed annuities, indexed annuities, and variable annuities.

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