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An annuity proposal: A case study.

Saturday, July 26, 2014


I would like to share this exchange which happened on Facebook just now and see if readers who do not follow me on Facebook have anything to say:

"I happened to ask for an annuity proposal recently. put in one lump sum at 50 and start drawing down at 55. AK, do you think this is a good deal?"

Click to enlarge.
My response:

"Basically, we are giving them $150,000 and letting it accumulate for 5 years before they start paying us.

"Conservatively, if we were to invest $150,000 for just a 4% dividend yield which is doable, we would receive $6,000 a year or $30,000 in 5 years, assuming we do not re-invest.

"So, in this case, at age 55, we should have $180,000 in the kitty (assuming investment value stays the same but I believe this is something of academic interest since we won't be able to sell the annuity and so, we have to assume, we won't need to sell the dividend paying stocks).

"Now, if we were to receive a 4% yield on $180,000 at age 55 onwards, we would get $7,200 a year. This is quite a bit more than the annuity payment of $530 x 12 = $6,360 a year. Of course, we can argue that there is a non-guaranteed portion to the annuity. Well, whether that portion will be paid or not is almost in the realm of speculation, isn't it?

"This annuity is, in my opinion, probably a good choice for people who are not very savvy when it comes to investments. I will also say that they want to consider a quarterly, half yearly or yearly payout instead of a monthly pay-out. If they choose a yearly pay-out, they get $20 more a month. They have to be quite disciplined and, of course, don't fall prey to the "magic stone sect".

"Just for the sake of comparison, for someone who is currently 55 years old and who has $155,000 in his CPF-RA, 10 years later, at age 65, under the CPF Life Standard Plan, he would be able to withdraw $1,221 a month. (This is more than double that of the private annuity plan.)


"If you like, ask the insurance company which proposed this annuity plan to provide another table which allows an accumulation period of 10 years instead of 5 years so that you can directly compare against the CPF Life which we are automatically covered under."



CPF Life Estimator.

I am just sharing my own thoughts and this is not meant to be any sort of advice.

If you have any thoughts on the matter, please leave a comment. I am sure we will all appreciate a constructive and civil discussion on the matter. :)

Related posts:
1. An annuity plan for retirement needs.
2. Achieving level 1 financial security.
3. Retiring before 60 is not a dream.

20 comments:

pf said...

I think the annuity is good. Dividends also not guaranteed. Principal sum invested in dividend stock also not guaranteed. Just leave the money in annuity and not think abt it.

Money unable to take out easily also good. Prevent the "magic stone" ppl, the poor relative who needs a big break in his business, the son who wants to be sent overseas for further studies or a big lavish wedding. Sorry for sounding so cynical. Hahaha....

By the time i am old, i shld not subject my heart to the ups and downs of the stock market. If i wanna play play to keep my brain alive, i should just have perhaps 50k of play money in equities.

I shld spend time to think abt what legacy i can leave for the young ppl, a part of me to impart. ..that stays behind, after i am gone. Something more than just money...

But that's just me. :)

AK71 said...

Hi pf,

Always good to have another perspective. :)

I believe the idea of an annuity is good but whether this particular annuity is good or not, I am not so sure. I like CPF Life. That I am sure.

However, I am also sure that this annuity will sufficiently meet the needs and demands of certain people, just not mine. ;)

You have raised an interesting question. What do I want to leave behind when I am gone, apart from money? Lately, I have been thinking more and more that it could be my blog. ;p

AK71 said...

From FB wall:

EHL:
1) if you're looking for higher than inflation rate returns, obviously you're looking at the wrong place

2) annuity is not meant to be an investment, it's an insurance

3) insurance is meant to hedge against uncertainty in living shorter than expected

4) insurance comes with a cost.. Hence the lower returns

5) the annuity is meant to give payouts consistently using what you've set aside to prevent the itchy fingers from disobeying the brain.

6) people who have actively invested are more likely to lose out to market, because of the itchy fingers. So you won't jeopardise your own retirement if even if you have sufficient amounts set aside for it.

AK:
It is an insurance product that generates returns from investments. If we are paying professionals to generate low returns, we could possibly do better investing the money ourselves, for people who know how. $150,000 is a large sum of money.

I think an annuity is a hedge against living longer than expected. LOL. Don't want to run out of money in case we live to be 100. Old and incapacitated, we would be grateful for annuities then. ;p

For an annuity, I believe nothing can beat CPF Life. I doubt that any other annuity can do better. I believe that is the one and only annuity I need but there will be people who are less financially savvy or disciplined and are probably better off getting one more annuity.

AK71 said...

EHL:
Nothing can beat the CPF life in terms of returns.. But then again..

The whole point of the insurance annuity is supposed to be an insurance..Insurance bro.. Not investment.. CPF life doesn't give you a death benefit.. Neither does it give you coverage against total permanent disability.

Most important is for the readers to understand what goes into the premiums they are paying for and whether they need it.

AK:
Er... Yes, I do understand the difference between insurance and investment.

Want death benefit and coverage against total and permanent disability? If we need the coverage, buy the insurance.

This blog post has its genesis in a question posed by Fast Twitch, "AK, do you think this is a good deal?" So, I am just sharing my thoughts on whether the annuity is a good deal as a tool for retirement funding which is what an annuity is meant to do.

I have also conceded that "This annuity is, in my opinion, probably a good choice for people who are not very savvy when it comes to investments." So, if people need it, buy it. I won't stop them.

There could be vested interests which are unhappy with my view on the product but that is to be expected but if they think that I don't know the difference between insurance and investment, well, so be it.

pf said...

Yeah. This blog is a great job! :)

AK71 said...

Hi pf,

I can only hope that my blog has done more good than bad. Of course, it is really for readers like yourself to decide if this is the case.

So, thank you very much for the encouragement. :)

sillyinvestor said...

Hi AK,

Just last week, I was taking to 2 colleagues who were planning about their option for pension. There were 3:
1) take everything at one lump sum
2) take 1/3 of lump sum and has a lower payout for the next 12 years, after 12 years the payout will normalized.
3) no lump sum, pay u until u die.

There were plenty of teasing from me about being a rice bucket. They opted for 2, but told me many of their peers opted for 1).

Those who opted for 1) their plans according from the mouth of my colleagues (accuracy unable to verify) is to just get a property and get rent.

They ask each other why not option 1) and they give candid self assessment that they are not good at investment

My thoughts are: property is also an investment, it can go quite wrong too.

To cut the story short,

Perhaps the focus should not be the merits and competitive strength of the annuity but the relevance and suitability of it for the person.

The other pension guy told me he will invest. I ask:" wow so you have been investing, so what instructments and assets u have. He mentioned a plan similar to what u post. But he gave 50k annually for 5 years and have a gestation period of 5 years. The returns is 3-4% only, if my off the head mental calculation is correct, but it is capital guaranteed. You can withdraw the capital anytime but u would have considered surrendering your policy and future payout. If he dies, the money goes to his beneficiaries plus death benefit.

My advice then is: it is a good investment, the chulk of money involved is not as high as property, maybe a quarter million compared to 1 million at least( eliminating leverage cost and risk). Investment portfolio value will go up and down, if we have not experience with investing, we might make all the wrong mistakes DIYing. Also, with so much money on hand, we might have itchy fingers and do a very expensive Europe tour?? They nodded in agreement. Lump sum investing at one go is seldom prudence unless you happen to receive your pension at 2009. But then, do they have the guts to invest???

Sorry... Too longwinded...

sillyinvestor said...

Oh no, just read the comments in detailed after I post it. The relevance of the product to the person is already discussed, and you are approaching from the angle of investment merits. Well, then we all know equity returns will beat insurance annuity returns hands down.

AK71 said...

Hi Mike,

Thanks for weighing in on this. :)

To be honest, I expected many more response to this blog post. Many more have insurance compared to investments, I was told. Well, maybe because it is a long weekend. ;p

I will say something that might make me sound like a government supporter but regular readers will know better.

If it is an annuity that we are after, why not simply do voluntary contributions to our CPF-SA (if we are still allowed to)? As an annuity, nothing can beat the CPF Life. Well, at least I don't know of any.

Having an annuity for retirement is a great idea. It is about risk pooling and having a retirement income for the rest of our lives. There is certainty and it gives us a peace of mind. However, being AK, I want the best value for money. ;p

OK, for someone who has maxed out his CPF-SA or RA, an additional annuity could be the way to fund his retirement years. This is one example I can think of.

sillyinvestor said...

Haha for the 2 rice bowls colleagues, their CPF while little, is already above min sum for CPF life.

Also for those buying annuity, it means they have hundred of thousand cash to spare, unless they are self employed or have a big house, it is highly likely that the CPF MS is already met.

AK71 said...

Hi Mike,

Haha... Well, if they have already met their minimum sum requirements and if they want another source of assured retirement funding, then, another annuity is a good instrument to have.

Your colleagues are luckier than 50% of CPF members who cannot meet the minimum sum requirement. :)

AK63 said...

Here we have the rich talking among the rich about where to put their extra riches, the envy of others lah....

Whoever can take out one big cash lumpsum to buy annuity is definitely not people who need to worry about life's woes lah....

Those who have SA already above MS and still considered having little got nothing to worry about lah....

As for those who can say those who are above MS and still have little are definitely better off than all the above lah....

And for those who have emergency cash stashed in war chests, cookie jars, biscuit tins, floorboards, hidden drawers and compartments, annual voluntary contributions to SA for tax relief and huge annual passive income on top of working income, really got absolutely nothing to worry about, not even what to leave behind, but maybe how much you can take with you? :p

AK71 said...

Hi AK63,

LOL. I had a good laugh. Thank you for reminding us what Sundays should be like!

A discussion about annuities is definitely too heavy a topic for Sundays. ;p

AK63 said...

That was off-topic and letting-off sour-grapes steam lah.... :)))

Let's come back to the annuity thinggie. I'm someone who after reading many books many times over and over again still cannot grasp the simplest of things kinda person and also not highly educated. But with my simplest calculation, I also think that this annuity is only 1/3 as good as CPF Life. $150k pays $6.6k+ yearly for 30 years and $150k under CPF Life pays minimum $1.2k monthly till death, how to compare?

AK71 said...

Hi AK63,

This is why I said I am not sure that this annuity is a good product but some might have misconstrued my intentions. ;p

Of course, I believe that an annuity is a good thing for retirement funding. I have to be bonkers to think otherwise.

However, if we are after an annuity to help fund our retirement, it could be a better idea to simply bump up our CPF-SA to meet that minimum sum to help us get as much out of CPF Life as possible. Do it and do it soon.

After all, I don't think we need more than one annuity and for anyone who agrees with me on this, just make sure we get the most we can get out of CPF Life by voluntarily contributing to the CPF-SA. Let the magic of compounding do the rest. :)

AK63 said...

I would like to second what AK71 just posted....

Annuities are great for retirement income but we don't need more than one, especially when existing ones are not comparable with CPF Life....

For those enviable ones, to max out your SA for the higher payouts at your DDA is the best option now. Other than all the benefits which were mentioned already, I don't find any other reasons to lock away huge sum of cash unnecessarily. Cash is always king, to be easily accessible in uncertain, unpredictable or drastic times. If one has enormous amount of cash but worry about losing it in risky investments, there's always the options of bonds and ETFs, which still generate sizeable income than insurance and annuity.

In my opinion, one only needs one annuity, one health plan for hospitalisation, one other plan for critical illnesses (best if there's combination of both), one life policy (if one still has worries) and the rest in accessible investments.

Solace said...

Dear AK,

A very good exchange of views I can see. Here goes my input.

1. CPF life is a good annuity plan on its own, I don't see a need to have another to replicate it.
2. I am wary of distribution costs and effect of deduction on all insurance products, ask the reader to check them carefully 1st. I always favor term insurance because of such expenses earned by agents n the insurance company.

Instead of another annuity plan, I favor dollars cost averaging approach in an index fund (e.g ETF). This is a simple and no frill way of investing and growing wealth over long term.

During working life, contribute some money to buy into index funds. Things should be ok with a long term horizon. When I am in my twilight years, I will withdraw (sell some shares) as and when I need the money.

The most likely reason for an index investing strategy to fail is that the investor simply gives up on it. And there are plenty of ways that could happen:

1. The investor panics during a recession and sells at the bottom
2. The investor abandons it for a " more exciting " strategy like investing in bit coins
3. The investor suddenly becomes convinced of his/her ability to trade forex or he believed he can alway pick stocks with multibaggers

index investing is simple and sensible. The hardest part of it is sticking to it for the long-term

AK71 said...

Hi Solace,

Thanks for weighing in on the matter. :)

I laughed a bit when I read the bit about bit coins. Oops. Too many bits. ;p

I agree with you totally but, ultimately, it really depends on the individual and what he is comfortable with.

Blog posts like this one have a tendency to step on some toes. We have to remember that someone who needs to bring home the bacon probably made this proposal. That someone and his friends are probably upset with me. :(

We can only offer our thoughts while that someone is actually qualified and licensed to give advice. People like us are walking on thin ice here. -.-"

I still remember how I had to take down a very good blog post by a guest blogger on insurance matters because he was threatened indirectly with job loss...

Solace said...

Hi AK,

I guess "That someone and his friends " should have something bigger to worry about than your blog post.

I am referring to this:
http://www.channelnewsasia.com/news/business/singapore/mas-to-help-consumers/1280994.html

"Mr Menon added that by early next year, consumers who do not require financial advice will be able to purchase term and whole life insurance products directly from insurers. Details will be announced by the end of the month."

This will somehow affect them more. But of course, this is good for consumers.

AK71 said...

Hi Solace,

I actually shared this article on my Facebook wall a few days ago too. Definitely a great development. Should have happened years and years ago. :)

"Speaking at the release of the MAS annual report, managing director Ravi Menon said a reason why consumers venture into unconventional and often risky products is that simple, lower-cost products are not easily available. He added that MAS will introduce a direct channel for consumers to buy insurance products. Such products will be cheaper as there is no need to pay for distribution costs.

"Mr Menon added that by early next year, consumers who do not require financial advice will be able to purchase term and whole life insurance products directly from insurers. Details will be announced by the end of the month."

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