What are the tax benefits of immediate annuities?

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tax benefits of immediate annuities

After toiling hard for 33 years, Ramesh Kumar, 58, is on the cusp of retirement from one of the most reputed engineering firms in the country. Retirement is supposed to be peaceful and comfortable, but Kumar is a worried man. Even though he has substantial savings, he did not actively plan for retirement. He has adequate health cover but needs a regular income to maintain his lifestyle. Has he saved enough for his retirement ? Kumar can explore various options, but investing in an annuity plan is likely to be the ideal choice.


What is an annuity plan?

An annuity plan is a contract between an individual and an insurance company, whereby the insurer promises to pay an amount at regular intervals to the individual in return for a lump-sum payment or a series of payments. The insurer invests the money received and pays back the returns generated from it to the individual. There are two types of annuity plans depending on the nature of payments.

Immediate annuity plan: These plans are purchased with a lump sum and the annuity payments start immediately either for a specified period or lifetime. There is no accumulation phase in immediate annuity plans and it starts working from the vesting phase.

Deferred annuity plans: These plans are similar to other investment instruments, whereby the money is invested for a specified period of time, and the annuity payments start after a certain date. It has two phases—accumulation phase and vesting phase. In the accumulation phase, the premiums are paid and the corpus is accumulated, while in the vesting phase you start receiving the policy benefits in the form of pension.

Benefits of an immediate annuity

An immediate annuity plan helps you live a secure and stress-free life after retirement. People have the surety in mind that they are entitled to receive payments until they die, even if they drain out the entire value of the annuity insurance plan before time. It is especially beneficial for people who did not actively plan for their retirement while they were working. While most insurers do not pay the corpus after the death of the annuitant, some companies provide an option of a life annuity with return of purchase price. The annuitant receives an annuity for his/her lifetime and in case of an unfortunate demise, the purchase price is paid to the nominee and the policy terminates.

To promote retirement planning, the government has allowed several tax benefits on contributing to an immediate annuity plan. The lump-sum amount paid for an immediate annuity plan is eligible for tax deductions under Section 80CCC of the Income Tax Act, 1961. The specific section of the Income Tax Act allows individuals to claim a tax deduction for contributions made to pension funds. However, the maximum deduction that can be claimed under Section 80CCC is Rs 1.5 Lakhs during a year on costs incurred in buying a new policy or continuing an existing plan that pays pension or a periodical annuity.

The deductions under the section are not limited to residents of the country, but can also be claimed by non-resident Indians who contribute towards a pension plan. It has to be noted that the deduction limit under Section 80CCC is clubbed with Section 80C and 80CCD, which essentially caps the overall limit at Rs 1.5 lakhs.

Even though the contribution qualifies for a tax deduction, the annuity payments are considered as salary and taxed accordingly. Regular income after retirement decreases gradually and annual income up to Rs 5 Lakhs is essentially tax-free. If the primary source of income is the regular annuity payments, you are most likely to have zero tax liabilities. An additional tax benefit on immediate annuity plans is the standard deduction allowed by the government on the gross salary. As annuity payments are taxable under the head ‘Salaries’, the taxpayer can claim a standard deduction of Rs. 50,000 or the amount of pension, whichever is less.

Conclusion

Even though immediate annuity plans offer several tax benefits, you should not look at annuity plans as a tax-saving instrument. Ideally, you should start retirement planning as early as possible. In case you are not able to save for your retirement, immediate annuity plans help you ensure a regular income. Immediate annuity plans can also be used to supplement retirement income from other sources.

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