Singaporeans are living longer and that’s great news! But if you’re concerned about outliving your savings during your golden years, an annuity can be a wise investment. We speak to Mr Christopher Tan, CEO of Providend, to find out how annuities can play a big part in our retirement plans.
As an insurance instrument, there’s nothing sexy about annuities. Except for the part where you put in money and get a monthly benefit for life. In that sense, when used wisely, annuities can be the ‘sexiest’ part of your retirement strategy.
The Benefits of Annuities
Annuities were designed to be a reliable means of securing a steady cash flow for an individual during their retirement years. As such, every retiree’s portfolio should include an annuity plan to hedge against longevity risk – the risk of outliving your savings.
In addition, there is a high chance that if a retiree received a lump sum payout, they would overspend during the first 5 years of retirement. When retirees are younger and more energetic, they tend to have a mindset that they should use their savings while they’re still able to. Annuities prevent overspending by providing a fixed monthly payout that instills a certain discipline to spend within our means.
Not just for the inexperienced
Contrary to popular belief, the more financially savvy you are, the more you should realise the need to own annuities. As an anecdotal example, I’ve just had a client who recently entrusted $3.2 million in annuities. My client used to be the Managing Director for one of the big banks, and he obviously understands investments. Yet, he chose to park $3.2 million in annuities. The main reason behind this is that he understands the need to hedge against longevity risk.
The best time to buy annuities is…
When you’ve retired or have 5 or so years left to retirement. As part of a retirement portfolio, annuities provide a steady stream of income at little to no risk for retirees who have a short runway to recover from potential investment losses.
From an advisory standpoint, if you’re younger with a longer runway, you would not want to lock yourself in a low return instrument like an annuity, because you can actually afford to take some risk.
At a younger age, you should be investing in a higher risk instrument such as equities depending on your risk profile, because you have a chance to ride out any risk. There is enough evidence that demonstrates that if you have at least between 10-15 years, you will never get a year of negative annualised return.
What about CPF LIFE?
Like an annuity insurance, CPF LIFE is a scheme that essentially converts your CPF retirement savings into a monthly stream of income after you retire. The difference between CPF LIFE and a retirement income insurance plan, is that retirement income insurance typically has a fixed payout period, but there is no such maturity for CPF LIFE.
CPF LIFE provides you with a monthly payout from age 65, for as long as you live. As the only annuity plan in Singapore underwritten by the Government with a triple AAA rating, and with risk-free interest rates of up to 6%1 a year, CPF LIFE is a no-brainer for seasoned financial advisors like me.
Since January this year, there’s a third CPF LIFE option – the Escalating Plan – in addition to the Standard and Basic Plan. With the 3 plans, members can choose how they want to draw down their savings in retirement. The Escalating Plan is essentially the Standard Plan, but with a 20% lower initial monthly payout which gradually increases by 2%2 every year.
Consider other financial instruments in addition to annuities for retirement
On the flip side, you may not have enough money to spend in retirement if you just depend on annuities alone. It’s an open industry secret that private insurance companies are finding it harder and harder to match the commitment they offer for annuities, due to the current low interest rate environment and increasing life expectancies.
Additionally, with its unbeatable, risk-free interest rates of up to 6% per year, CPF LIFE has changed the face of the private annuities market. As such, insurance companies have now evolved to create shorter-term retirement income plans and ‘retirement income’ products that help complement CPF LIFE.
Lastly, if you do invest to boost your retirement savings, don’t overlook the impact of sequence of returns risk – which would affect your rate of return depending on when you withdraw money from your investments. For instance, if you retire during a financial crisis, to get the same amount of money, you will be forced to withdraw more from your investments at a lower price. This affects the amount of capital left invested and could result in you using up your money faster than planned. On the other hand, if the market is financially stable during the early years of your retirement, your overall financial situation will be fine even if the market dips during the latter half of your retirement as your capital has had time to grow with interest. One way to exert control over the variable situation described above, is to diversify your investment over different financial instruments like stocks and bonds.
In conclusion, annuities should always be part of a retiree’s retirement portfolio. When choosing an annuity plan, you should know your retirement goals, understand how the annuity helps you accomplish those goals and check that you understand all the fees and restrictions of the annuity product you are considering. You should also understand when your stream of income should start, what other investment options are available, and how the annuity complements other investments you have.
1 Currently, CPF savings in the Ordinary Account earn interest rates of up to 3.5% per year, while savings in the Special, Medisave, Retirement Accounts and the annuity premiums earn interest rates of up to 5% per year. These interest rates include an extra 1% interest paid on the first $60,000 of the combined balances (with up to $20,000 from the Ordinary Account). Since January 2016, CPF members aged 55 and above will earn an additional 1% extra interest on the first $30,000 of their combined balances (with up to $20,000 from the Ordinary Account). This is paid over and above the current 1% extra interest that is earned on the first $60,000 of their combined balances. As a result, CPF members aged 55 and above will earn up to 6% interest per year on their retirement balances.
2 Payouts under the CPF LIFE Escalating Plan grow at 2% per year to preserve the purchasing power of the payouts. As with all CPF LIFE plans, payouts may be adjusted to account for long-term changes in interest rates or life expectancy. Such adjustments (if any) are expected to be small and gradual.