This article is part of our complete guide to insurance in India, and connects to the retirement side of our investing guide. Life insurance protects against dying too soon. An annuity protects against the opposite risk: living longer than your savings. Here is how annuities and pension plans work, the options you must choose between, and how to use them without locking up too much.
The Short Answer
An annuity plan turns a lump sum into a guaranteed income, usually for the rest of your life. You hand a life insurer a purchase price; it pays you a fixed amount every month, quarter or year, at a rate locked in on the day you buy.
An immediate annuity starts paying straight away and suits people at or near retirement. A deferred annuity or pension plan collects premiums or a lump sum now and starts the income later. The trade-off is the same in both: you get certainty of income for life, and give up access to the capital and protection against inflation. The income is taxable.
An annuity is insurance against a long life. Buy enough to cover the bills you cannot skip, and invest the rest.
The Two Types
Immediate and deferred annuities
| Immediate annuity | Deferred annuity or pension plan | |
|---|---|---|
| How you pay | One lump sum | Regular premiums or a lump sum |
| When income starts | From the next payout date | After a deferment period you choose |
| Suits | Retirees converting savings or a retirement corpus into income | People still working who want guaranteed income later |
| Rate locked | On the day you buy | Often only when the income starts, depending on the plan |
| Main risk | Locking in a rate and losing access to the capital | Low returns during the deferment period |
Deferred pension plans from insurers often deliver modest returns during the build-up years. Before buying one, work out its real return with our policy IRR calculator and compare it with simply investing and buying an immediate annuity at retirement.
The Choices
Annuity options: the decision that sets your income
When you buy an annuity you choose an option, and in most plans the choice cannot be changed later. The more the option promises to your family, the lower your income.
| Option | What it does | Income level |
|---|---|---|
| Life annuity | Pays for your lifetime; stops at death, nothing returned | Highest |
| Life annuity with return of purchase price | Pays for life; the purchase price goes to your nominee at death | Lower |
| Joint life, last survivor | Pays while either spouse is alive | Lower |
| Joint life with return of purchase price | Pays while either spouse lives; the purchase price goes to the nominee after both | Lowest of these |
| Increasing annuity | Income rises by a fixed percentage each year | Starts lower |
| Guaranteed period | Pays for a fixed minimum period even if you die early, then for life | Slightly lower |
A married couple usually needs a joint life option, so that the income does not stop when the first spouse dies. Return of purchase price suits people who want to leave the capital to their children, but it costs a meaningful slice of income.
Saral Pension: the standard plan
IRDAI requires every life insurer to offer Saral Pension, a standard immediate annuity with identical features across insurers: a life annuity with return of purchase price, or a joint life last survivor annuity with return of purchase price. Because the features are the same, the comparison comes down to the annuity rate and the insurer’s service.
The Arithmetic
What an annuity pays, and what it costs you
The income is the purchase price multiplied by the annuity rate. At an illustrative rate of 7% a year, ₹50 lakh buys an income of ₹3.5 lakh a year, about ₹29,000 a month, for life. The rate depends on your age, the option you choose and interest rates on the day you buy: older buyers get higher rates; return-of-purchase-price and joint options get lower ones.
- Inflation: a level annuity buys less every year. At 5% inflation, ₹29,000 a month has the buying power of about ₹18,000 after ten years.
- Liquidity: the purchase price is usually locked in for good. Some plans allow surrender only in limited cases, such as critical illness.
- Rate timing: the rate is fixed when you buy. Buying everything when interest rates are low locks that rate in for life.
Using It Well
How to use an annuity in a retirement plan
- Cover the floor, not everything. Use an annuity for essential monthly costs: food, utilities, medicines, rent. Keep the rest invested for growth and emergencies.
- Pair it with a withdrawal plan. The invested part can fund rising expenses through a systematic withdrawal plan, which keeps pace with inflation better than a level annuity.
- Ladder the purchases. Buying annuities in two or three stages, for example at 60, 65 and 70, spreads interest-rate risk and gets higher rates at older ages.
- Keep health cover separate. An annuity is income, not a medical fund. Keep adequate health insurance into retirement.
- Size the whole plan first. Our retirement calculator shows the corpus you need before you decide how much of it to annuitise.
NPS
Annuities and the National Pension System
NPS subscribers must buy an annuity with part of their corpus at exit, from a life insurer empanelled as an annuity service provider. Under rules PFRDA eased in December 2025, a non-government subscriber exiting normally can take up to 80% as a lump sum and must annuitise at least 20%. Smaller corpuses can be withdrawn fully: up to ₹8 lakh on normal exit. On voluntary exit before 60, at least 80% must still be annuitised if the corpus is above ₹5 lakh. Everything in this article about choosing options applies to the NPS annuity too.
Tax
Tax treatment
- Annuity income is taxable every year at your slab rate. There is no exemption for pension received from an annuity.
- Purchase price: a lump sum paid for an immediate annuity does not earn a deduction. Premiums to an insurer’s pension plan may count within the ₹1.5 lakh deduction limit under the old tax regime.
- Return of purchase price paid to a nominee at death is a return of your own capital.
Because the full annuity is taxable, compare annuity income after tax with the after-tax return on alternatives such as the Senior Citizens’ Savings Scheme, debt funds or a withdrawal plan.
Avoid These
Common annuity mistakes
1. Annuitising the entire corpus
It leaves nothing for emergencies, large expenses or inflation. Annuitise the essential-expense floor only.
2. Choosing a single-life option when a spouse depends on the income
The income stops at the annuitant’s death. A joint life option protects the surviving spouse.
3. Buying a deferred pension plan without checking its return
Many deliver less than a simple combination of investing during working years and buying an immediate annuity at retirement.
4. Ignoring the insurer’s service record
An annuity is a relationship that may last 30 years. Check how the insurer handles life certificates, payouts and nominee claims.
Key takeaways
→ An annuity plan converts a lump sum into guaranteed income, usually for life, at a rate fixed on the day you buy.
→ Immediate annuities start paying at once; deferred annuities and pension plans start later and often return little during the build-up.
→ The option you choose sets the income: life only pays most; joint life and return of purchase price pay less but protect your family.
→ Use annuities for essential expenses only, pair them with invested savings, and consider buying in stages.
→ Annuity income is fully taxable; NPS subscribers must annuitise at least part of the corpus under PFRDA rules.
Questions
Frequently asked questions
What is the difference between an immediate and a deferred annuity?
An immediate annuity is bought with a lump sum and starts paying income at once. A deferred annuity collects money now and starts paying after a deferment period you choose.
Is annuity income taxable in India?
Yes. Annuity income is added to your income every year and taxed at your slab rate.
Which annuity option is best for a married couple?
Usually a joint life, last survivor option, so that the income continues for the surviving spouse. Adding return of purchase price leaves the capital to the children but reduces the income.
What is Saral Pension?
A standard immediate annuity that IRDAI requires every life insurer to offer, with identical features: a life annuity or a joint life annuity, both with return of purchase price. You compare insurers on rate and service.
How much of my NPS corpus must buy an annuity?
Under PFRDA’s December 2025 rules, a non-government subscriber exiting normally must annuitise at least 20% of the corpus if it exceeds the thresholds; up to ₹8 lakh can be withdrawn fully.
Can I surrender an annuity?
Generally no. Most immediate annuities cannot be surrendered; some allow it only in specific cases such as critical illness. Treat the purchase price as committed for life.
Keep Learning
Next steps: Retirement calculator · SWP calculator · Policy IRR calculator
The bigger picture: The complete guide to insurance in India
About the author
Ujjwal Tiwary
ARN-144500 · NISM Series V-A certified since 2018 · Ranchi & Deoghar, Jharkhand
Ujjwal Tiwary is an AMFI-registered mutual fund distributor (ARN-144500) based in Ranchi and Deoghar, Jharkhand, and has held the NISM Series V-A certification since 2018. He works with families on mutual funds, insurance and income tax returns, and writes or personally reviews every article on FactFinances. He is not a SEBI-registered investment adviser; nothing on this site is personalised advice.
Disclaimer: FactFinances provides educational content only. This article is for general information and is not insurance, tax, financial or legal advice, and does not recommend any specific product or insurer. Insurance is the subject matter of solicitation. The annuity rate used is illustrative only; actual rates depend on age, option, insurer and interest rates at purchase. NPS exit rules are as notified by PFRDA in December 2025. Tax treatment depends on your circumstances and the regime you choose, and plan features vary between insurers; the policy wording governs. ARN-144500. Regulatory information: IRDAI.