About Annuities Part 2

Annuities comes in different forms. Today we will talk about the types of annuities available in the market.

Firstly we understand that annuities serve as an income distribution vehicle in our retirement years, or for some it may be used as a form of passive income during the life stage of financial independence.

1. FIXED ANNUITIES

Fixed annuities serve to provide a fixed income for a certain period of time the insurer guarantees. Each payout each year is fixed. Taking for example the latest CPF Life Annuity proposed by CPF Board, it is considered a fixed annuity because it promises a payout of example $610 a month for the rest of your life after age 65. The same amount of $610 in the CPF Life is fixed and it does not change, it does not take into account inflation or the time value of money. Since its payment if for life, say over 20 years, the value of money can change and its lowered value due to inflation will have some impact on the standard of living for someone who only relies on this CPF Life annuity.

2. VARIABLE ANNUITIES

These serve to provide a variable income based on the underlying performance of the invested funds in single subscription. It can also provide an income for a guaranteed period or for life. The payout is fixed at a percent of the current account value of the subscription. Or it can be looked as an increasing percentage of the single initial capital outlay. For example, Manulife’s Secure Retirement Plus provides an increasing percentage of payout each year because of loyalty bonus and the locking in of investment profits. If the underlying investment grows by 25% over 5 years, and the payout is 5% of the capital injection, say 5% of $100,000 = $5000 pa. the capital will have increased to $125,000 and thus the new payout has increased from 5% to 6.25% of the initial subscription. This continues to grow and despite market downturns and if the account value drops, the payout is still based on the previous higher account value.

Now through a variable annuity, the payout is now hedged against inflation and in ideal times, it out performs the rate of inflation, in conservative times, it at least gives a respectable match to inflation, in the worst times, it gives the basic fixed income.

With the above explanation of the 2 types of annuities, variable annuities have began to catch up in more highly matured financial markets as people begin to realize the importance of the impact of inflation.

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