An annuity is an insurance product that turns a lump sum into a regular income, usually for the rest of your life. You give an insurer a sum of money, and in return it pays you a fixed periodic amount. Annuities can be immediate or deferred, single-life or joint-life, and the income is taxed as income and largely illiquid once bought. This is exactly what the mandatory 40% of an NPS corpus purchases at 60.
The trade at the heart of it is simple: you swap access to your capital for a predictable income for life, though a fixed payout still loses purchasing power to inflation.
Annuity basics
What is an annuity?
An annuity is a contract with a life insurer. You pay a lump sum, called the purchase price, and the insurer commits to paying you a set income at regular intervals, most often monthly, typically for life. It is the mirror image of saving: instead of building a corpus, you are converting one into a steady stream.
The point of an annuity is longevity protection. Because the payments continue for as long as you live, an annuity removes the risk of outliving that income stream, one of the hardest problems in retirement. What it does not remove is inflation: most annuity payouts are fixed in rupee terms, so their real value shrinks over a long retirement. That lifelong certainty, inflation aside, is the product's core appeal.
Immediate versus deferred annuities
Annuities split first on timing.
- Immediate annuity. Income begins soon after you hand over the lump sum. This suits someone at or near retirement who wants to start drawing a pension right away.
- Deferred annuity. You buy it earlier and payments start at a chosen future date. The money accumulates in the meantime, and income begins when you actually need it.
The choice is about when you need the income, not which is superior. Someone retiring today leans immediate, someone planning a decade ahead may consider deferred.
Common annuity types
Beyond timing, annuities differ in what happens to the income and the capital. The main variants:
| Type | How it works |
|---|---|
| Life annuity | Pays for your lifetime, then stops |
| Joint-life annuity | Continues to your spouse after your death |
| Return of purchase price | Pays for life, then returns the original sum to your nominee |
A plain life annuity usually pays the highest income, because the insurer keeps the capital when you die. A joint-life or return-of-purchase-price option pays a lower income in exchange for protecting a spouse or leaving the capital behind. You are choosing which risk to cover, and paying for it in a lower payout.
How annuities are taxed
The income from an annuity is taxed as income in the year you receive it, at your slab rate. There is no special exemption on the pension itself. This matters when you estimate real monthly income, because the headline payout is a pre-tax figure and your slab decides what you actually keep.
Where NPS fits
Annuities are not an abstract product for most Indians, they are built into NPS. At 60, at least 40% of your NPS corpus must be used to buy an annuity from an approved insurer, while up to 60% can be taken as a tax-free lump sum. The pension you then receive depends on the annuity rate at that time, which is why the eventual income cannot be pinned down in advance. The full exit mechanics are in NPS withdrawal rules, and the account itself in what is NPS.
The trade-offs
An annuity buys certainty and pays for it in flexibility. The income is dependable and lifelong, but the capital is illiquid, the payout is taxed, and once bought you generally cannot reverse the decision. It is one tool for retirement income, not the only one. Alternatives like a systematic withdrawal plan keep your capital invested and accessible but shift the risk of the money lasting back onto you, as covered in retirement income strategies.
Related NYVO guides
- What Is NPS? The National Pension System Explained – the account whose 40% rule makes annuities relevant to most savers.
- Turning a Retirement Corpus into Monthly Income – annuities alongside SWP, buckets and other income methods.
- Atal Pension Yojana (APY): How It Works – a government-backed scheme that pays a fixed pension.
An annuity is best understood as insurance against living too long, not as an investment. It gives up growth and access to secure a lifelong income, though most payouts are fixed and not inflation-indexed, and whether that trade is worth it depends entirely on how much certainty your retirement needs.
