Ask Melanie

Making a cautious case for insurance-linked annuity plans

Melanie Nutbeam, a certified financial planner based in Hong Kong, addresses common personal finance queries. Send your questions to

PUBLISHED : Monday, 05 November, 2012, 12:00am
UPDATED : Monday, 05 November, 2012, 3:25am

I save regularly into an investment portfolio managed by my adviser and am happy with that. I'm 45, and this portfolio will be my only source of income in retirement. I could add a bit more each month, but my adviser suggests using the extra savings to buy a lifetime annuity instead. What are your thoughts on this?

Your current arrangements assume you can manage your retirement portfolio to provide income and capital to last your lifetime. Most people attempt this through a combination of timed withdrawal of income yield and capital. This requires careful calibration, with the right assumptions about risk, return and income needs.

It's tricky, and estimates can be thrown if market returns diverge from historical averages, especially at the brink of retirement - a point dramatically highlighted for baby boomers retiring just ahead of 2008.

With increasing life spans, the risk of outliving capital, especially where there's no fall-back pension, is significant.

The annuity plans sold by insurance companies address this longevity risk (the risk of outliving your retirement savings). The insurer pledges to pay investors a set income, for life. Some people live longer than others. The insurer and their actuaries look at the returns of the pooled assets for the group, and the expected longevity rates of policyholders, and run the numbers. Your bet is on personal health and a long life.

Twenty years ago, annuities were complex, expensive and generally a bad deal. You effectively gave a lump sum to an insurance company in return for its contractual undertaking to pay you an income for life. If you died the next day, the insurance company kept your capital.

People preferred to keep and manage their own capital, hoping they wouldn't outlive it. Lifetime annuity sales declined. Insurance companies were forced to rethink. Insurance companies in the United States have developed more consumer-friendly policies. Some of these firms have offices in Hong Kong and offer localised versions of the plans.

While some policies can be bought with a single lump sum, insurers prefer to sell plans involving regular contributions through the years. This is partly because it allows the insurance company to better manage investment inflows.

Typically, there's flexibility to make lump-sum withdrawals and suspend savings during the initial stage of the plan period.

But be aware that the penalties for early withdrawal can be steep.

If the policyholder dies before the plan matures, the insurance firm will pay out at least some money to beneficiaries. This feature addresses a long-standing complaint about the instrument - that people died before the plan paid out, such that the policy expired worthless.

It takes a while to understand and compare annuities, as they are complex. Some plans can be dismissed quite quickly - on the basis of provider risk, costs and returns, or inflexible features. As always with any investment, if you don't understand it, don't buy it.

You also need to be extremely cautious about your savings commitment because you are contractually committed to making payments for your chosen term.

Likewise, be aware that the plans can involve high selling commissions. You need to be clear on your adviser's motives for recommending a plan. Ask your adviser to clearly state, in writing, the full commission they are earning for selling you a plan.

But assuming you understand the plan and its fees, an annuity product that pays a guaranteed income for life can make sense.

The views presented are of a general nature. For specific advice, talk to a professional planner. See the column archive at