What is effective annuity rate and is CPF Life competitive?

A reader read an article in The Straits Times on CPF Life and asked me to write a piece on it.

I have blogged about CPF Life so much already and, so, to avoid boring anyone too much, I will try to keep this short.




This is taken from a recent chat with another reader:

foolishchameleon said...
... with so many annuities in the market, what returns would be considered decent?
2.5%? 3% ?

AK said...
What is a decent return? I have not done any comparison lately but I know none is able to come close to what CPF Life is able to generate which is a minimum of 4%.
However, if it is only 2.5%, I might as well just do annual VC to my CPF account as the OA pays 2.5%. So, intuitively, I would demand at least 3% from a private annuity.

(Source: https://singaporeanstocksinvestor.blogspot.sg/2017/10/how-insurance-weakened-familys-balance.html)

So, when the article in The Straits Times says CPF Life is able to offer a 7.1% effective annuity rate based on $100,000 premium, what are we looking at here?

We are not talking about effective interest rate here. 

We are talking about effective annuity rate.

If we are talking about interest rate, then, based on $100,000 savings in our CPF-RA, the first $30,000 gets 6%. Next $30,000 gets 5%. The rest gets 4%.

Average interest rate is 4.9%. 

I hope my math is up to scratch.





An annuity rate is not interest rate as it refers to how much is paid out as a percentage of our premium each year.

So, in the CPF Life example mentioned in The Straits Times, a 7.1% annuity rate based on $100,000 gives us $7,100 a year or $591.66 per month from age 65 for life.

It isn't a 7.1% interest rate.

It is quite clear that annuity rate and interest rate are different especially when we remember that some of this regular payout is a return of capital which is why at some point in our old age, when we pass on, there is nothing left for our beneficiaries.

Source: 
The Telegraph, 17 May 2017.

Taken from the article in The Straits Times:

The report highlighted that with CPF's interest rate structure, CPF Life is able to provide an effective annuity rate of 7.1 per cent based on a $100,000 premium.

"This compares favourably with life annuities in most markets," stated the report. The annuity rate was calculated based on the ratio of annual payout to premium paid, for a male member born in 1962, or is 55 this year, who receives payouts at age 65.

It is no wonder that financial experts like Mr Christopher Tan, chief executive of Providend, believes that every retiree's portfolio must include an annuity plan to hedge against longevity risk.


He says: "CPF Life is currently the best annuity plan in the market. It is low-cost and offers high return."




Read full article here:
http://www.straitstimes.com/business/invest/is-the-new-cpf-life-plan-ideal-for-you

Related posts:
1. An annuity.
2. Retirement funding.
3. CPF Life Escalating Plan.