Page 180 - DMGT515_PERSONAL_FINANCIAL_PLANNING

Unit 10: Retirement Planning-II

amount of capital, such as lottery winnings or inheritance. Immediate annuities convert a cash Notes
pool into a lifelong income stream, providing you with a guaranteed monthly allowance for
your old age.
Deferred annuities are structured to meet a different type of investor need - to contribute and
accumulate capital over your working life to build a sizable income stream for your retirement.
The regular contributions you make to the annuity account grow tax sheltered until you choose
to draw an income from the account. This period of regular contributions and tax-sheltered
growth is called the accumulation phase.
Sometimes, when establishing a deferred annuity, an investor may transfer a large sum of assets
from another investment account, such as a pension plan. In this way the investor begins the
accumulation phase with a large lump-sum contribution, followed by smaller periodic
contributions.

Perks of Tax Deferral

It is important to note the benefits of tax sheltering during the accumulation phase of a deferred
annuity. If you contribute funds to the annuity through an IRA or similar type of account, you
are usually able to annually defer taxable income equal to the amount of your contributions,
giving you tax savings for the year of your contributions. Also, any capital gains you realize in
the annuity account over the life of the accumulation phase are not taxable. Over a long period
of time, your tax savings can compound and result in substantially boosted returns.
It’s also worth noting that since you’re likely to earn less in retirement than in your working
years, you will probably fit into a lower tax bracket once your retire. This means you will pay
less taxes on the assets than you would have had you claimed the income when you earned it. In
the end, this provides you with even higher after-tax return on your investment.

Retirement Income

The goal of any annuity is to provide a stable, long-term income supplement for the annuitant.
Once you decide to start the distribution phase of your annuity, you inform your insurance
company of your desire to do so. The insurer employs actuaries who then determine your
periodic payment amount by means of a mathematical model.

The primary factors taken into account in the calculation are the current Rupee value of the
account, your current age (the longer you wait before taking an income, the greater your payments
will be), the expected future inflation-adjusted returns from the account’s assets and your life
expectancy (based on industry-standard life-expectancy tables). Finally, the spousal provisions
included in the annuity contract are also factored into the equation.
Most annuitants choose to receive monthly payments for the rest of their life and their spouse’s
life (meaning the insurer stops issuing payments only after both parties are deceased). If you
chose this distribution arrangement and you live a long retirement life, the total value you
receive from your annuity contract will be significantly more than what you paid into it. However,
should you pass away relatively early, you may receive less than what you paid the insurance
company. Regardless of how long you live, the primary benefit you receive from your contract
is peace of mind: guaranteed income for the rest of your life.
Furthermore, your insurance company – while it is impossible for you to predict your
lifespan – need only be concerned with the average retirement life span of all their clients, which
is relatively easy to predict. Thus, the insurer operates on certainty, pricing annuities so that it
will marginally retain more funds than its aggregate payout to clients. At the same time, each
client receives the certainty of a guaranteed retirement income.

LOVELY PROFESSIONAL UNIVERSITY 175