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Annuities: How To Tell Whether They’re Right For You

For decades, annuities were neither popular or promoted in Hong Kong. But in 2018, the Hong Kong Government launched an annuity plan to address the city’s rapidly aging population.  These products haven’t historically appealed to the Hong Kong market, but now that the new plan has raised public awareness, other insurance companies have begun promoting their own annuities. Read on to learn how these vehicles work, and whether they might be a smart choice for your own retirement.

The Hong Kong Mortgage Corporation launched its government-approved Annuity Plan in July 2018, open to Hong Kong citizens over 65 years of age.  True to conventional wisdom, initial reaction to the Plan has been lukewarm.  Only 9,410 people subscribed, with a total premium of HK$4.94 billion, which is less than half of the target amount*. To enhance the plan’s attractiveness, in December 2018 HKMC added new features like emergency withdrawal and a higher premium limit.  It remains to be seen whether this will successfully boost subscriptions.

Among the unfavorable feedback received on the HKMC annuity plan, “low rate of return” was by far the most common complaint. But this concern reveals a fundamental way that many people misunderstand how annuities work.

Insurance, not investments

At their core, annuities are a sort of insurance policy.  You pay a lumpsum premium now, in exchange for a guaranteed, pre-set monthly payment for as long as you live.  When you die, any remaining premium goes to whatever beneficiary you’ve named.  In short, annuities aim to protect what you already have, not maximize your eventual profits.

Many unforeseen circumstances could arise during our old age.  For instance, right now we can (perhaps)competently manage our investment portfolio for higher returns. But in our twilight years, we’re not guaranteed the same intellectual agility or independence. Annuities offer insurance against contingencies like that.

Those who are into numbers crunching can evaluate annuities by calculating the PV (Present Value) of the cash payments, then comparing it against the PV of your premium payment(s). Alternatively, some people calculate the IRR (Internal Rate of Return) of the cash payments, and take it as an indicator of the “return” of an annuity.  These calculations are indeed useful in comparing different annuity products.

You should not, however, compare the “returns” of an annuity to that of an investment (eg. stock, bond,etc.) because they’re inherently different.  For starters, the “return” from an annuity depends heavily on how long you live – and unless you’re clairvoyant, you likely don’t know that information.

The Underwriter

Since annuities represent a life-long insurance policy, it’s good to size up that policy’s underwriter.  Private insurance companies might offer better and more flexible terms.  The Government, on the other hand, is presumably the most reliable, with the lowest default risk.  It also provides the coverage as a social benefit, instead of a for-profit enterprise. We don’t need to worry about commercial fraud, or scrutinize the fine prints for hidden terms that might work against our interest. At this moment, however, the Government plan is only available to those 65 years of age or over.

Premium Payment Terms

Instead of a lump-sum premium payment, as in the HKMC plan, many annuities allow for monthly premium payments for a fixed time period, up to your retirement age. These plans function like a forced retirement savings plan, which might work better for younger people planning for retirement at an early age.

Plan Structure

The HKMC plan is the simplest and most straightforward type of annuity.  Some annuities offered by insurance companies might be more complicated, with additional features like cash bonuses, discretionary interest payments, early withdrawal provisions, etc.  If you have already bought life and/or other savings insurance policies, ensure you have a holistic picture when considering annuities.  Each type of insurance should serve a specific purpose, and ideally should not overlap.  Avoid complicated plans that you don’t totally understand.

Annuities can be a useful component in retirement financial planning, but should not the only component.  Your retirement nest egg should center on a well-balanced asset portfolio, supported by MPF and insurance – of which an annuity is just one type.  No matter your age, it’s worthwhile to stay informed on what annuity products are on offer, in order to see whether any of them is useful for you.

Remarks: Figures as of December 2018. 

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