Annuity and pension sound similar to people who do not have sound financial knowledge. However, both of these concepts are extremely different from each other and used in different situations. An annuity is generally paid for a certain time period, and it continues until the annuity survives or the person receiving it is alive. It is basically a contract with an insurance company that promises to pay you, the buyer, a stable income stream in the future. You first pay a lump-sum amount and receive it in segments.
On the other hand, a pension is the amount of money which is regularly paid by the central authority, like the government or a company, to their ex-employee after they have retired. This money is paid every month (or as agreed in the organisation’s contract) while the person is alive. The pension fund is also maintained by the employee (and employer, in most cases) during their term of employment.
Key differences between Annuity and Pension –
- CONTROL: The first major difference between the two is that of control. Annuities are voluntary in nature, and nobody is bound to have an annuity as they reach their retirement stage. An investor can purchase a scheme after reviewing the options if they think it will benefit them later. Whereas pension is involuntary, every government organisation needs to provide their employees with a pension fund as they retire. Investing in pension funds is not a choice and is mandatory, decided by the employer. One has no control over this.
- PROTECTION: The next difference is its protection stage and how they are protected. Annuities are generally not backed by the government. Some of them are guaranteed by the state government, at max, in which the organisation is conducting the business. On the other hand, pensions are always backed by the state government, making them safer for long-term benefit purposes because there is no scope for fraud or retracement.
- INCOME: Both pensions and annuities provide you an income until the time you die. They also provide tax advantages, although different in nature for both. Pensions lower your income tax as the amount you contribute is deducted from the salary. Annuities are always purchased with the after-tax income, hence, not lowering the overall taxes you pay.
Comparing Annuity and Pension
| Particular | Annuity | Pension |
| Product Type | Annuity is an insurance product. | Pensions are a retirement product. |
| How to Buy | An annuity is purchased from a financial services company like an insurance provider. | The pensions cannot be bought from anywhere. It is paid by the government to their employees as a. Mandate. |
| Definition | An annuity can be considered as a retirement product since it is given to the person as they reach their retirement age (which in most cases is around 60). However, a person reviving annuity may not have to completely retire to avail the benefits since the money is given in segment as and when they pay the lump-sum amount to the insurance company. | Pension funds are the benefit that one receives throughout their life once they retire at or around the age of 60, as the guidelines of their country mention. |
| How is it Calculated | Annuity is based on the investment amount that an investor invests towards the annuity scheme. That amount is then divided into smaller segments to be paid over a period of time with the added interests. | Pensions are calculated based on the income earned by the person during their service and is adjusted with respect to the years they served for. The higher they earn throughout their employment, the higher the pension is going to be. It also depends on the designation they resigned at. If they resigned at a senior level designation, the retirement pension is going to be higher compared to someone who retired at a junior level. |
| Payout | With an annuity scheme, the person receives a lump-sum amount together if they enrol in the scheme. | Under a pension scheme. A lump-sum amount is given, too. However, the difference is that here the lump-sum amount is given every month. |
| Advantage | Annuity advantage consists of the fact that an individual can choose, select and open a plan according to himself/herself and their own choice. They have the right to decide the amount they want to invest and the contract they are going to sign for whatever period of time is feasible to them. When an annuity is funded with after-tax money, the amount that they receive is not liable to pay taxes on, giving them a tax benefit. | Pension advantage is that an individual is working in the organisation since the employer is the same one who has been contributing and handling the payouts. There is no need for a contract and the only basis pension relies on is that if you are working in the organisation, you are going to receive pension when you retire. Hence, you do not have to research, choose and select plans explicitly. |
| Guarantee | Annuities are not guaranteed. | Pensions are guaranteed. |
Conclusion
We have now understood how annuities and pensions broadly differ. Both of these help you in your retirement stage, but their origin is polar apart. One has variation over fixed earnings as per the contract (annuity), whereas the other is a fixed earning no matter what (pension). All in all, both the schemes help you survive even after you have stopped working due to age or an illness and support you with a decent income needed to sail through life seamlessly.
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