BT: Annuities: making nest eggs last

Business Times - 14 Jan 2008

Annuities: making nest eggs last

Check out the payout sum and period, the underlying returns and the insurer's track record before buying one, says CRYSTAL NEO

DON'T feel compelled to rush to buy annuities before the compulsory annuity scheme kicks in. There are some factors you should consider first - and yes, age is one of them.

You must understand what annuities are. They are contracts which provide periodic payments for an agreed-upon span of time. Among them are those that offer periodic payouts for a fixed number of years. Then there are life annuities which make such payouts for the duration of the annuitants' lives.

The key insurance role of annuities is to cover people against the risk of outliving their resources.

Associate professor Fong Wai Mun of the National University of Singapore Business School describes annuities as a retirement product. He says that while they are important financial planning tools, you should shun them if you are young.

A younger person has to pay more for an annuity due to the high cost sustained by the insurance company, which would have to pay out for many more years.

But insurance companies are quick to point out that retirement planning is one area that younger people tend to overlook.

'A young person needs to start saving early to accumulate sufficient funds for retirement needs. Annuities are one of the most important tools for retirement needs,' an NTUC Income spokesman says. 'The more you save and accumulate to purchase an annuity, the higher the monthly payout you will receive from it.'

While annuities seem to have made the news only in recent years, they're not all that new. Annuities date back to Roman times.

Contracts made during the emperor's time were known as annua, or 'annual stipends' in Latin. The annua promised an individual a stream of payments for a fixed term, possibly for life, in return for a one-time payment.

Financial planners and insurance industry players say that Singaporeans are often reluctant to buy annuities due to the low payouts. Most people usually opt to leave their money with the Central Provident Fund (CPF) until age 62, when they can draw a higher monthly payout of $790 for 20 years.

In comparison, the life annuity products on the market now pay some $400 to just over $500 a month for an initial investment of $99,600 - the current CPF Minimum Sum - although the payments last for life.

In his National Day Rally speech last year, Prime Minister Lee Hsien Loong acknowledged that the returns on annuities were not very attractive, but he still insisted that 'we do need annuities as part of our old age planning'.

Associate professor Benedict Koh at the Singapore Management University Lee Kong Chian School of Business says that while the drawdown for annuities is available only after age 82, most Singaporeans worry more about the immediate future - the ability to finance their retirement years from 62 to 82. And that's why they are not so keen on annuities. Also, the amount of payout per month is very low to live on in Singapore.

Another reason Prof Koh cites is that by participating in the compulsory annuity scheme, Singaporeans will receive less payout from the CPF minimum sum from age 62 to 82.

He adds: 'If they die before 82, they will be hit by a double whammy. They die prematurely (most want to live longer) and they lose the capital used to purchase the annuity (they prefer that this sum goes to their loved ones).'

According to an AIA spokesman, annuity take-up rates tend to be driven by compulsory schemes and/or tax incentives in most countries. The lack of both here has meant that the take-up has been low.

In Singapore, the current Minimum Sum annuities offered by insurers provide a lifetime monthly annuity benefit which is lower than the monthly benefit offered by the CPF Board. The public may prefer a higher benefit as they do not fully apprehend the possibility that they may live longer than expected.

A safety net

Prof Fong says that the many misgivings that Singaporeans have about annuities stem from a lack of understanding of, or disregard towards, annuities.

One way Singaporeans can expand their knowledge on the issue is by checking out the Monetary Authority of Singapore and the CPF websites, he says. Other ways to dispel doubts include reading financial books or speaking to financial advisers.

At AIA, for example, customers can go through a financial health check, a process that involves identifying their goals, establishing priorities and assessing their available options to help them achieve these goals.

'When planning for retirement, some of the important questions that we would help you to answer include: what are my retirement goals, how much do I need to finance my retirement goals, how much do I need to invest to achieve my desired retirement income, what financial obligations will I have now and when I retire?' the AIA spokesman says.

Prof Koh says that some key issues that people should consider when deciding to buy annuities would be the period of payout, which should ideally cover the person's lifespan; the amount of payout, which should be sufficient for living expenses; and the underlying returns quoted by the issuer because a higher return ensures larger payouts.

Looking for an insurance company with a good track record in the annuity market is especially important when buying participating annuity plans, the NTUC Income spokesman adds.

Both Prof Koh and Prof Fong agree that annuities have become more important in financial planning in recent years as people are living longer.

Prof Koh says that annuities are particularly important for people who have limited savings for retirement. 'The compulsory annuity scheme proposed by the government allows pooling of risk so that the annuity payout is enough for subsistence living and the drawdown period is for life.'
And Prof Fong feels that while annuities should not be the only protection in old age, virtually everyone should buy them.

'The very rich don't need annuities because they have enough money to last for a long time,' he says. 'But for people with a healthy background who expect to live long, it is a form of guaranteed payout.

'For many who are not prepared financially, every dollar helps. So annuities are like a safety net.'