Question

If you purchase and annuity from an insurance company, what do you owe?

Illustrate the three pillars of the retirement table.

Answer 1

An annuity is a financial product that pays out a fixed stream of payments to an individual, and these financial products are primarily used as an income stream for retirees. Annuities are created and sold by financial institutions, which accept and invest funds from individuals. Upon annuitization, the holding institution will issue a stream of payments at a later point in time.

Annuities were designed to be a reliable means of securing steady cash flow for an individual during their retirement years and to alleviate fears of longevity risk of outliving one's assets.Annuities can also be created to turn a substantial lump sum into steady cash flow, such as for winners of large cash settlements from a lawsuit or from winning the lottery.

Defined benefit pensions and Social Security are two examples of lifetime guaranteed annuities that pay retirees a steady cash flow until they pass.

To help with retirement savings, traditionally, in any country, there is a three-tier or three pillar retirement framework.

The three pillars are:
Pillar 1- Public pension
Pillar 2- Occupational pension
Pillar 3- Personal pension

Pillar 1- Public pension
The first pillar caters to the need of social insurance and hence called the public pension. Aimed primarily at the old and poor, such pension plans are completely financed by the government.An example of this is the Indira Gandhi National Old Age Pension Scheme. It provides monthly assistance of Rs 200 and Rs 500 to people above 60 years and 80 years, respectively, who to belong to below poverty line families.

Pillar 2- Occupational pension
The second pillar caters to the salaried individuals, i.e., where there is an employer-employee relationship, either in a government set-up or in private companies. In 2004, the government transitioned from defined benefit (DB) to defined contribution (DC) pension for all employees joining from January 2004 (excluding defence services).

Government employees who entered service prior to 2004 would, however, continue to get pension in the form defined benefit. Government employees need to mandatorily contribute towards National Pension System (NPS). Unlike in DB-based pension DB system, in NPS the growth during the deferment period and even the annuities during the post-retirement period are market-linked and hence is not a fixed amount.

For private sector employees, though, contributing to NPS is optional unlike EPF which is mandatory. The return in EPF unlike in NPS are set by the government each quarter of a financial year and are linked to the yield of government securities.

Pillar 3- Personal pension
The third pillar caters to voluntary savings directed towards one's retirement. This could your investments towards any financial product like the Public Provident Fund (PPF), NPS, Atal Pension Yojana, retirement plans of mutual funds, pension plans of insurance companies, bank fixed deposits or through any other scheme where funds are earmarked for one's retirement.