Singapore-based financial blog that aims to educate people on personal finance, investments, retirement and their Central Provident Fund (CPF) matters.

Thursday, 9 October 2014

Annuities, Have or Not-to-Have

04:10 No comments

Today's topic will be on annuities. The average public have the tendency to buy annuities thinking that they are the best product available in the market for future cash flows, especially during retirement.

Actually, many people do not know what an annuity does, how it works, and how is it beneficial. So today I am going to breakdown what annuities are about.

By definition from Investopedia:

 In simple sense, you basically do the following thing:
  1. Find an insurance company/bank and buy a annuity from them
  2. What usually happens is you pay a monthly or yearly amount to them (say you start paying at age 30).
  3. You keep paying until you reach retirement age (say age 60) and after that, the bank/insurance company starts paying you a monthly income to sustain your living.
Sounds like a simple, beautiful and "cannot-go-wrong" thing?

On the consumer/buyer side, it is this simple. But it gets more complex when it goes to behind the scenes. This is what the financial institutions do with your money on general.
  1. They take your money (monthly or annual), pay commissions to the person who managed to get you to buy the product.
  2. The remainder gets invested into bonds, stocks, and other financial products.
  3. The investment returns they make, the institutions would take a cut to pay for their expenses (say 5%-10% of the returns).
  4. What is left is then given back to the consumer over a period of time as income.
 Still convinced that it is a great product? Read below on its risk:
  1. If the bank/insurance company goes bankrupt, you lose your annuities paid (depending on situation you MIGHT get back some of your money back).
  2. Hypothetically, for every $100 you put into the product, imagine some money going to the agent, some money going to pay for the institutions' expense, and the remainder (probably $80-$90) gets invested.
  3. The institutions use your money to buy stocks and bonds, then they take a cut from your returns. This means they cannot actually give you better returns than if you just invest in stocks and bonds yourself (sure there are risk investing yourself, especially if you know nothing. But, if you are investing for your retirement, read to know that investing might not be as dangerous as you think!).
Ken Fisher, a long-time Forbes columnist and well-known guru investor shares his hate for annuities.
Watch the video to learn more about the product!
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