Life Annuity at 65

People are living longer.  Many people may not realise that longer life expectancy will have a significant impact on their personal finance and standard of living. 

Let us take an example of a person at age 65, with an accumulated savings of $100,000.  This can come from the CPF minimum sum or personal savings. 

If this sum is withdrawn over 20 years at a guaranteed interest rate of 4% per annum, the payout is about $601 per month. 

The interest rate of 4% is the current interest rate payable on the retirement account in the Central Provident Fund. This rate may change in the future, as it will be pegged to the Government bond rate. 

Based on the death rates of the population in 2005, about 39% of males and 53% of females are projected to survive to age 85. For these people, their total savings will be depleted in 20 years time. 

7% of males and 11% of females are expected to survive for 30 years to age 95.  

To be prudent, they should be encouraged to draw down their savings over 30 years, instead of 20 years. In this case, the payout will drop to $473 a month, but it can last for 30 years.  

The trouble is, a monthly sum of $473 is smaller and there is still a risk (albeit smaller) of running out of cash after 30 years.  

Get ready for another shock! 

The chance of running out of cash is actually much higher. Why? Due to falling death rates, people are living longer. 

Over the past 25 years, death rate has been falling by an average of about 3.0 %  a year. This trend is likely to continue for the foreseeable future.  

For males at 65 now, 52% is likely to survive to 85 years and 24% to 95 years. For females, 65% will survive to 85 years and 32% to 95 years. 

Even if you choose to draw down a smaller payout of $473 over 30 years, the chance of running out of cash is still quite high, i.e. 24% for males and 32% for females.

Is there a better solution?  

Get ready for a surprise! The answer is “buy a life annuity”. 

If you use $100,000 to buy a life annuity at age 65 and it is administered to give an investment yield of 4% per annum, you will get a payout of 619 for a male, and $551 for a female.  The payout is higher than a 30 year drawdown scheme.  

If the invested sum is higher or lower than $100,000, the payout will be adjusted proportionately. 

Why is a life annuity able to give a higher payout compared to the 30 year drawdown scheme? 

The savings of all life annuitants are placed into a common pool. An financial expert, called the actuary, calculates the number of people likely to survive each year and receive a payout. Those who die earlier will leave behind the balance of their savings to make the payout to those who live longer. The calculation can be made quite precise to give the highest possible payout to the annuitants. 

Every annuitant hopes to live longer and to receive a payout that is more than the money invested. This is possible only if those who die earlier leave their balance in the pool.  This is called pooling of the longevity risk. 

Without pooling, each annuitant has to do his own calculation. They have to be prudent and draw down a smaller monthly sum, so that the money can last longer. 

Can the annuitant insure against the risk of dying earlier? 

Yes. It is possible to opt for an annuity that provides a partial refund of the initial investment, in the event of early death. A scheme can be designed to guarantee 20 years of payment. If the annuitant dies within 20 years, the remaining payment, that is, 20 years less the amount paid out, will be given to the estate immediately.  

The monthly payout under this kind of “with refund” annuity will be $498 for a male and $486 for a female. Compared to the “no refund” annuity, the payout is lower by 20% for a male and 12% for a female.   

The annuitant can choose a larger payout under the “no refund” annuity or a smaller payout under the “with refund” annuity.  

The Government plans to introduce a longevity insurance scheme to pay out a monthly sum of $300 to a person from age 85.  From 65 to 85 years, they draw down a monthly sum from the retirement account. 

I believe that a life annuity payable at 65, not 85, may be better for most ordinary people, compared to the longevity insurance. 

Tan Kin Lian

The writer is a qualified actuary and served as CEO of NTUC Income for 30 years prior to his retirement. He writes a blog www.tankinlian.blogspot.com. 

The calculations are based on the death rates of the population, with projection for future improvement in mortality. It assumes an investment yield of 4% per annum and ignore expenses and profit margin.  

These calculations are made to educate the public about the principles of a life annuity and do not reflect the commercial terms that may be offered by any specific annuity provider.