Life Annuity - the simple facts

A life annuity is a contract for a customer (annuitant) to pay a lump sum into a fund and to receive a monthly payment during his or her lifetime. 

The amount of the monthly payment depends on: 

• The amount paid to buy the annuity
• The future yield on the investments of the fund
• The future lifespan of the annuitant
• The expenses and profit margin of the insurance company

An annuity provides two valuable services for the annuitant. It frees the annuitant from the hassle of investing the money for many years. It allows a pooling of the longevity risks, as the annuitants who die earlier leave behind the balance of their money to pay the monthly payment to the annuitants who live longer. 

In Singapore, an employee is required to contribute to the Central Provident Fund (CPF) during the working career. At one time, it was possible for the employee to withdraw the entire savings and accumulated interest from the CPF on reaching 55 years. 

In the late 1980s, the Government made it compulsory for a CPF member to keep a Minimum Sum in the CPF at age 55, and draw out the rest of the savings in a lump sum. 

The minimum sum has been adjusted over the years, and is now $99,600 for members reaching age 55 in 2007. This sum is kept in the retirement account until 62 and can be drawn down in monthly installments of about $790 over 20 years. This is based on an interest rate of 4 percent.  If the interest rate changes, the monthly drawdown will have to be adjusted. 

The CPF member is allowed to invest the minimum sum in a life annuity to be paid from age 62 for their lifetime. 

Several insurance companies offer the life annuity plan. However, their payout is substantially lower than $790 a month. Less than 5% of CPF members invest in the life annuity.

The most popular is a participating plan that pays a lower sum at age 62, but increases the amount of the monthly payment each year, depending on the investment yield of the fund.  

The Government wants to encourage CPF members to buy the life annuity as the savings can be stretched over a lifetime, and does not stop after 20 years. At the present time, more than 50 percent of people at age 62 is expected to live longer than 20 years. This proportion is expected to increase in future years, as more people live longer. 

At present, the life insurance company can earn less than 3.5 percent from investing the savings in secure government bonds. It has to deduct the marketing and administration expenses and a profit margin.  

After allowing for these charges, the payout is less attractive than the drawdown scheme provided by CPF. 

This comparison may change in the future, as the Government has announced some changes concerning the interest rate payable on the retirement account.  The actual details have not been disclosed yet. 

My guess is that many people will continue to keep their minimum sum with the CPF, instead of using it to buy a life annuity. For people to make a decision to buy a life annuity, they have to be convinced of a clear advantage to do so.  

To avoid the situation about money running out after 20 years, the Government has decided to make it compulsory for the retiree to buy a life annuity that is payable from age 85, after the retirement account has been fully spent.

The amount that is needed to be taken at age 55 from the minimum sum to fund the after-85 life annuity should be quite small. I estimate that it will take much less than 5 percent of the minimum sum. The cost will even be lower, if the Government provides a subsidy or shoulders some of the uncertainties in the future cost. 

The compulsory after-85 life annuity applies only to CPF members who are now less than 50 years old. They will buy the compulsory annuity when they reach 55 years in 5 years time.  

Here is my personal view. 

I prefer a simple life annuity starting at age 65, instead of the proposed drawdown cum after-85 annuity arrangement.  The payout under the life annuity can be made quite attractive, if it is administered by the CPF which continues to pay out an effective interest rate of 4 percent on the savings that are transferred to the annuity fund. 

It is desirable for the annuity to be compulsory. The only objection can come from people who are in poor health, and are likely to lose out from an early demise. In that case, they can be given the option to pay an annuity plan that pays out a lower monthly sum, and refund the balance of their capital on early death. 

In many countries, it is quite common for their citizens to draw out a lifetime pension payable by the state or the employer or both.  This is similar to a life annuity. 

Up to now, the discussion on life annuity appears to be confined only on the investment of the CPF minimum sum.  

We must not forget that many retirees have personal savings, apart from this CPF minimum sum. These savings have to be invested as well. 

It is advisable for a retiree to invest a large part of the personal savings in a life annuity and enjoy the advantages of professional investment and pooling of longevity risk. 

Compared to other forms of investments, the life annuity does offer, in most cases, a better return.  

The life annuity can offers some attractive options:

• Participating or non-participating plan
• Refund of balance of capital, in event of early death
• Deferral in the starting date of the payment

Each option affects the amount of the monthly payment. You have to consider which options suits you best. A financial adviser can help you to make the best decision. 

Tan Kin Lian 

The writer qualified as an actuary in 1975. He served as chief executive of NTUC Income for 30 years prior to his retirement in 2007.