Question:
Does a compulsory retirement annuity have an expiry date which will allow the balance of the policy to be paid out in full?
Answer:
Colleen,
A compulsory retirement annuity does not have an expiry date – the annuity you purchase must provide you with an income for life. The annuity you receive therefore factors in your life expectancy at the age you take out the annuity.
The annuity is in effect an insurance policy that protects you from the risk of longevity and low market returns. There is thus no "balance" that relates to your specific purchase. This is different from a fixed-term annuity that winds down to a zero balance.
Below is more information on how guaranteed annuities work, and the different types on offer.
A guaranteed life annuity (also known as an underwritten or traditional annuity) will provide you with a specified monthly pension for the rest of your life. You must purchase this annuity from a life assurance company, who assumes the longevity risk (the risk that you live longer than expected) as well as the investment risk (earning sufficient return on your capital to pay your pension).
The full pension is paid until you die. The drawback is that your capital dies with you, and no money passes onto your heirs. That is your risk: you (or, indirectly, your heirs) forfeit your savings in the event that you die sooner than expected (unless a guarantee or life assurance is built into the contract).
Annuity rates (the pension that you receive) are variable and can differ from one life assurance company to the next. As you may receive a different income for the same amount invested, you should shop around for the best available rate at the time.
Life assurance companies consider a number of factors in determining your annuity rate:
1. Your age: the younger you are, the longer you are likely to live, and hence the lower your monthly pay-out.
2. Your gender: women have a higher life expectancy than men, on average, and therefore receive a lower pension.
3. Interest rates: the higher the prevailing interest rates, the higher your monthly pension is likely to be.
4. Your choice of annuity: you have a number of product options, with different risk profiles. In general, the less uncertainty you are willing to accept in respect of your monthly pay-out, the lower your annuity is likely to be.
Products:
Level or fixed annuity. You receive the same amount every month for the rest of your life. This means that your income does not grow with inflation; the purchasing power of your annuity (and hence your standard of living) will thus gradually decline.
Escalating or variable annuity. This annuity increases annually, either by a fixed amount, or in line with a pre-determined inflation index, such as the Consumer Price Index (CPI). An escalating annuity will pay out less than a level annuity initially, but will maintain its purchasing power and thus gradually overtake the fixed annuity in value.
Guaranteed and then for life annuity. This annuity will pay out less than the first two, as it shields you from the risk that you die soon after retiring and thus forfeit the bulk of your retirement savings to the life assurance company. This annuity (fixed or variable) is guaranteed for a set number of years (typically between 10 and 20); should you die within the guarantee period, your heirs will continue to receive your pension for the remainder of the guarantee period. You will continue to receive your pension after the guarantee period, but the payments stop upon your death (ie your heirs no longer benefit).
Capital-back guaranteed annuity. This combines an annuity (fixed or variable) with a life policy. Your annuity is reduced by a premium, which pays for a life assurance policy, to the benefit of your heirs.
Joint and survivorship annuity. This annuity ensures that your spouse will have an annuity (fixed or variable) after your death. You select the income level your surviving spouse will receive (typically 75%). This is recommended for couples where only the one spouse has accumulated retirement savings. This type of annuity pays out less than a single person annuity, as the longevity risk increases for the life assurance company.
With-profit annuity. This is an escalating pension, guaranteed for life; however, the rate of increases is not guaranteed and depends on the net (after cost) investment performance of your initial investment. Increases are declared as bonuses; and once declared, become permanent (ie part of your guaranteed pension). Pension increases are subject to smoothing, ie the life assurance company holds back some of the profit made in high-return years, to soften the blow of low-return years.
Enhance annuities. In exceptional circumstances, you may qualify for an enhanced annuity if you can demonstrate that your life expectancy is below average due to your ill-health or poor life-style choices.
