Sunday, August 16, 2009

Annuity: your No.1 Asset Class for Retirement

by Christopher Pua

What is an Annuity?

Annuities are plans that allow you to accumulate tax-deferred funds for retirement and then you (the annuitant) can opt to receive a guaranteed income usually payable for life or for a specific period of time. Alternatively, you can call it your retirement income for life. The objective of an annuity plan is to ensure that you will have a continuous stream income during your retirement years and for as long as you are alive. So, it protects you from outliving your resources. Thus a life annuity is a form of longevity insurance, where the uncertainty of the annuitant’s lifespan is transferred to the insurer. And the insurer is able to take on this risk by applying the law of large numbers and hence reduces the uncertainty by pooling many clients. Currently, annuity plans are sold by insurer through their appointed Financial Planners/Advisors or other authorized Financial Institutions under the regulation of the MAS.

Single vs. Regular Payment Annuity.

Typically, there are two modes of payments available to an annuitant. One can either pay a lump sum premium, in which case is called a Single Payment Annuity or choose to pay a series of regular premium, in which case is called a Regular Payment Annuity, prior to the onset of the annuity.

Stages or Phases

There are usually two stages or phases in an annuity plan. The first stage is referred to as the accumulation phase. During the accumulation phase, the annuitant deposits and accumulates money into an account for the plan over a period of time. The second stage is referred to as the distribution phase. During the distribution phase, the insurer starts the annuity and pays out a regular income to the annuitants on a monthly/quarterly/semi-annually/annually basis for as long as the annuitant is alive. Having said these, there is also immediate annuity in which there is no accumulation phase. A lump sum payment is made by the annuitant and the annuity income starts immediately until the annuitant’s death. The annuity plan with both accumulation phase and distribution phase is called a deferred annuity plan.

Types of Annuity Plans

There are many types of annuity plans available in the market. The most common of these are immediate annuities, fixed annuities, equity-indexed annuities and variable annuities. 
Immediate annuities pay owners a set amount of money on a predetermined schedule (monthly, quarterly, annually, semi-annually). 
Fixed annuities are interest-based vehicles similar to bank-issued CDs, but they offer a higher minimum interest rate and are extremely low-risk. They typically offer returns of between 3% - 10% for essentially no risk and hence they are popular choices for conservative investors. Equity Indexed annuities on the other hand, can achieve a greater return than the annual minimum rate because it earns interest that is linked to a stock or other equity index. Variable annuities are extremely flexible and are typically invested in mutual funds, therefore are subject to the same risks as stocks, bonds and mutual funds. Variable annuities are best for more aggressive investors.

Is CPF Life an Annuity?

Yes, CPF Life is an annuity and currently all CPF members who turned 55 starting Sept 2009 will be able to buy into this plan using the money from their RA(Retirement Account). The money in the RA is actually the CPF money set aside as your minimum sum and transferred over from your SA(Special Account) and OA(Ordinary Account) when a CPF member turns 55. At the present moment, I would always recommend my client to buy into the CPF life as their first annuity plan as it pays the highest rates in the market right now. Then, to supplement the CPF Life you should take up another private annuity plan from one of the private insurer. Currently Manulife has two annuity plans that pays up to 4.2% per annum on the sum insured for the duration of the annuitant’s life. One of the plan called 3-Gen comes with a life insurance component, whereas the second plan i-Gen does not and hence also do not require any medical underwriting, make it an ideal plan for annuitant who may have a medical condition.

A Word of Caution

Setting up an annuity can be an incredibly confusing and complicated process and many people interested in annuities have questions about the process: Are annuity payments taxed? Are withdrawals from a deferred annuity taxed? Which is the best annuity choice for me and my family? 
Your best bet is to consult a Financial Planner to ensure that the annuity you pick is the best possible fit for your family and your financial situation.

a blog on: Financial Planning Advice - Christopher Pua

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