Pensions and annuities are two great kinds of retirement income. But don’t confuse one with the other. They are two different instruments with their own advantages and disadvantages. Let us see what they are and which one would be more appropriate.
What is a Pension?
It is a type of retirement account which is mandatory for Government employees but is also recommended for private-sector employees to secure their retired life. The fund is opened and maintained with regular contributions throughout employment.
Some companies offer pension to their employees as part of the job (Employees’ Provident Fund or EPF) while others can voluntarily opt for other pension schemes (PPF/ NPS). In the case of private sector employees, the employer manages the contributions and payouts, which is one less worry on your end. Even if the company suddenly goes bankrupt, the Pension Benefit Guaranty Corporation will try and get you your pension as much as they can. You may not get the entire amount but you will still have most of it.
An important feature of pension is the tax exemptions as you receive the payments on your retirement under Section 80C (PPF, EPF, NPS, etc).
As far as maturity is concerned, you generally have two options.
- You can receive monthly payments which give a regular source of retirement income.
- You can choose to get your pension as a lump-sum amount. This way you can get the entire amount at once and use it as you like.
At the time of your retirement, you receive payouts regularly or in a lump sum, depending on the scheme that you opt for. The amount you receive depends on several factors like your age, salary and the duration of your employment.
What is an Annuity?
It is similar to an insurance scheme. You make a deal for a stipulated amount of money and pay the money at one shot or through deposits regularly. Your money is invested in mutual funds, stocks or bonds. The specifics like the amount you receive, maturity, etc. are set by you. When the time comes, if you retire or not, you start to receive your payments from the annuity.
A big advantage of annuities is that if you use your income-after-taxes to fund the annuity, then your pay-outs are totally tax-free. Suppose you exhaust your pension completely, you can open an annuity that lasts till your death.
On the whole, a pension needs very little planning on your part because it is likely to make most of the payouts as the law protects pension payments. Whereas with an annuity you receive a fixed stream of payments by buying it with some or all of your pension ‘pot’.
When it comes to deciding which of the two is ideal for you, it is best to look at your lifestyle, planned retirement corpus, spending capacity, etc. It will help you understand which one is more beneficial for your retirement as per your requirement and circumstances.