“ Save for retirement. Start from your first paycheck.”
Chanda Kaushik
If you have been around investment circles for a bit, you must have heard people talk about buying an annuity at retirement, especially if they were employed in the formal sector. An annuity refers to an amount of money payable at a certain point in time, usually in the future and for an agreed period.
To understand annuities, we start at the beginning.
Difference between Pension funds and Provident funds.
Both provide a means to save for retirement and there is no difference in terms of administration, that is, for the contributor. However, upon attaining the appropriate retirement age, a provident fund will surrender to you, all your savings together with the interest earned from the investments, as a lump sum. The National Social Security Fund is a good example of a provident fund.
On the other hand, if you will have been saving in a pension scheme, then at retirement and by the prescribed law, you will only access up to a third of your investment as a lump sum. With the remaining two-thirds, you must purchase an annuity.
It is important to note that one can as well purchase an annuity with the lump sum benefit from a provident fund voluntarily. As a caution, it is important to pick a retirement saving scheme that is regulated by the Retirement Benefits Authority.
Enter annuities, mind you not all annuities are made equal. Depending on the insurance firm and your preferences, you could get an annuity for a capped period of say 5,10, or 15 years or you could choose to have it for life.
While we are still laying down the groundwork, we might as well distinguish between annuities and income drawdown plans.
Difference between an Annuity and Income-draw down plan
Now, an income drawdown plan should not be confused for an annuity. In an income drawdown plan, your lumpsum pension amount is invested and the income drawn is according to your discretion.
The income drawdown plan is flexible in that you determine when to receive the income, such as monthly or quarterly, and how much you want to receive until you exhaust your funds.
Annuity funds operate differently mostly because they are more restrictive in nature. Because they offer a guaranteed income, sometimes for life, then they must give an income sustainably.
The insurance firm, therefore, determines how much should be paid and in what intervals, based on the lumpsum invested.
Of course, since both annuities and income drawdowns are aimed at providing an income during retirement, most insurance firms will stipulate a minimum period, usually at least 10years, just to safeguard the pensioner’s interests.
Importance of Annuities.
- Guaranteed income during retirement
As alluded to earlier, Annuities have various options spanning from a period of 5 years,10 years,15 years, and ultimately for life. This helps to give a pensioner a regular income during retirement when they are not able as much as they did when they were younger.
- Tax-free income after the age of 65 years
The Income Tax Act provides that an annuity drawn by a pensioner after 65 years is tax-free. This is a big incentive especially since income sources at that time may be few or far between. It serves to boost the pensioners’ cashflows which are critical
- Death Benefit for survivors
This is usually a rider provided, as long as the pensioner has drawn down the annuity for the prescribed minimum cooling period, which can be anything from a minimum of three years. It gives a financial cushion for the pensioner’s beneficiaries so they
- Optional medical insurance
This is not inclusive of the annuity per se; however, insurance firms have noted the gap in providing medical insurance for pensioners and have taken this up as a value add to the annuities they already have. Some of them negotiate attractive premiums that are then netted off from the periodical payments.
Two of the most chronic problems at retirement for most people is that they did not save at all or secondly, they have some assets that are not cash generating that is they are asset rich while cash poor.
As I always preach, start saving early because compound interest is your best friend. It is disheartening to see someone who worked for so many years and then suffers abject poverty in retirement, especially because it becomes difficult to remedy such a situation. As much as you can, start now, start small but do start!