One of the greatest fears in planning retirement funding is about running out of money during retirement. If we only knew how long we would live and the quality of our mental and physical condition during our future, our personal financial planning could be more accurately achieved. In many ways, retirement annuities address some of these concerns. Today, we consider how annuities operate.
An annuity can be established by saving/contributing funds over time to an account for which the lump sum accumulated after the period of saving/contributing is converted to repayments to you over time, usually on a monthly basic. Retirement annuities are guaranteed to provide monthly payments for your lifetime at a minimum.
Examples of retirement annuities are the National Insurance pension scheme, company pension schemes, registered deferred annuities, registered retirement saving plans and voluntary pension contributions. The major advantage of these retirement annuities is that they will guarantee payment of the annuity amount for life, however long (or short) that may be. Â
For the National Insurance pension benefits, payment of the annuity is guaranteed for life only; no further payment is made after death. However, for the other retirement annuity examples given, the annuitant is required to choose from various annuity payment options starting with the highest amount of the annuity payment being for one’s lifetime only. Â
Then the amount of the annuity payment reduces gradually in value as the guaranteed period for payment after death is extended. For example, typical options ranges are for five years certain or life; for ten years certain or life; and for 15 years certain or life. No matter how long you live, the annuity amount will be paid, but the longer you guarantee that the payments are to be made even if you die, the lower is the annuity amount.
The National Insurance pension benefit annuity has a complex basis of computation along with specific entitlement restrictions. It is funded over time by contributions from the employee and the employer. The scheme provides a worthy annuity payment provided that you can live long enough to enjoy a ten- to 15-year period of benefits.
For the other retirement annuities, in addition to the 25 per cent tax-free withdrawal (commutation) that is allowed, here are some examples of the approximate annuity payment for life for the balance of the lump sum accumulated:
For a lump sum saved of about $25 000, the annuity would be about $150 monthly; for $100 000, the monthly payment would be in the $600 range; and for $500 000, the monthly payment would be in the $3 000 range. These estimates provide guidance in funding their retirement for those persons who are self-employed, or have an inadequate employer pension plan and who wish to supplement their pension.
Retirement annuities are typically not well understood especially by the sale agents, making it difficult for the purchaser to make an informed decision on the upfront investment. In addition, some annuity plans are laden with layers of fees which significantly erode the resulting annuity payments. Furthermore, to the extent that the annuity payment is fixed and does not reflect inflationary increases in costs in some way, the longer the annuity period, the greater the erosion in real value of the annuity payment over time.
Overall, the evaluation of one retirement annuity plan compared to another can be quite an involved process especially in getting the relevant decision-making information. Yet, establishing a retirement annuity is still considered one of the best avenues for supplementing retirement income. The retirement annuity approach offers the opportunity to plan better the level of retirement funding which we need to afford our planned retirement lifestyle.
• Louise Fairsave is a personal financial management adviser, providing practical advice on money and estate matters. Her advice is general in nature; readers should seek advice about their specific circumstances. This column is sponsored by the Barbados Workers’ Union Co-op Credit Union Ltd.
