Should you get an endowment plan or annuity for your retirement?
An edited version of this article was published in the 17 June 2018 issue of ZaoBao. Below are our original interview answers in English, by Shawn Lee, Assistant Vice President of GYC.
1. What's the difference between annuities and endowment plans?
Annuities are typically plans which are meant to reduce the risk of outliving one's resources. As such, an annuity is typically used as a tool for retirement planning. Most annuity plans pay a regular income for as long as one lives.
On the other hand, endowment plans are typically insurance policies which help you to save so as to provide a lump sum at a fixed date. An endowment plan is useful in meeting a fixed financial goal, e.g. funding your children's overseas university education. One other difference is that should you suddenly die or contract a critical illness, the insurance component will then be activated to still provide the lump sum at maturity without any further payment of premiums, or provide an immediate payout with the termination of the plan.
However, the difference between such plans is getting increasingly blurred as insurers respond to market demands and become more creative with their product offerings. It is now common to find Endowment plans that have features which also pay a regular income over a fixed period.
2. Which is more suitable for people in their 40s and 50s? (Assuming the question is directed at retirement funding needs)
For retirement funding, regardless of the type of plan, it is always preferable to start as early as possible to enjoy the benefits of compounding.
There are now endowment plans available which allow you to decide when you would like to receive a regular payout, as well as the end date (i.e. length of payout period). This could be particularly appealing to people in their 40s or younger, as a way to supplement their income.
Annuities typically start the payout at the standard retirement age, e.g. 62 or 65, and will appeal more to people in their 50s who are more focused on funding their retirement years.
However, it is important to know that suitability should be determined based more on individual circumstances like available cash flow (being able to regularly set aside a fixed amount to fund the policies), financial objectives and understanding your risk appetite. If one has a long investment horizon or accumulation period, one should also consider plain vanilla investment options (e.g. investing in a global equity fund) or a combination of both. Equity (stock) investments have a higher rate of return and more liquidity over the long term, but come with higher risks and volatility as compared with endowment policies which give a lower rate of return but are less risky.
Insurance type products also typically come with lower liquidity compared to most investment products, which means that you would not be able to take out your money from endowment or annuity policies in case of emergency needs without suffering a penalty.
3. How do you choose a suitable endowment plan?
A useful checklist is to consider the three P’s: Purpose, Present Situation, and Product.
i. Purpose
Some questions to think through:
What is your financial objective? Education funds for your children, or income during your retirement years?
When do you need the money, and how much? Is the money required upfront (e.g. paying university fees) or spread over a longer period (e.g. retirement needs)?
How much risk can you take? (which is also somewhat related to how long it will be before you need the money)
Figuring out the purpose of getting a plan will be very useful in determining if endowment plans are suitable options and how to employ this to meet your financial objective.
e.g. If the objective is to provide income during retirement, one should look at plans that provide a higher annual payout with low or no maturity payout over plans that pay a lower (or no) annual payout and a higher maturity payout. Having a big sum of money at 80 years old is not always useful, versus having a higher monthly income to supplement one's retirement expenses from 60 years old.
ii. Present situation
Understanding your present financial situation (e.g. what you can afford to set aside regularly) will help to narrow down your options and determine how much you can afford and for how long.
Endowment plans usually require a long term commitment and premiums are typically higher than traditional whole life insurance policies. It is important to ensure that you do not overcommit your financial resources.
iii. Product
(what to look out for in an endowment)
Participating or non-participating plans. If participating, do look at the guaranteed and non-guaranteed payouts. Guaranteed maturity or payout values may not necessarily be higher than the total amount of money you put into the plan.
Keep it simple. Adding too many riders (insurance options) will result in lower returns on your investment (ROI) as the additional premiums paid for riders do not participate in the overall policy returns
Is a high regular payout or a high lump sum payout at maturity more important to you? There is a trade off, and you need to be aware of this.
Track record of the insurance company
Remember that as there is usually a maturity date for all endowment plans, it might not be the best option for purely protection needs.
One other important point to take note of is who you are seeking advice about such plans from. Do they have vested interests to sell you plans from a particular insurer, or do they represent many insurers? It is always best to seek independent fiduciary advice to get the best plan for your needs.
4. Pros and cons of buying an endowment plan
Pros:
Smoothing of benefits in an insurance policy means less volatility and higher predictability than most investment saving options. Hence it can be a good option when funding is required at a specific time, e.g. education.
Guaranteed returns provided by the insurance company
Insurance coverage to ensure that your financial need is met even if you suddenly cannot pay the premiums due to death or critical illness (with the relevant riders)
A disciplined way of saving over a period of time
Cons:
Long commitment period required
Inflexible – Premature termination or changes usually involve a penalty and you may get back less than what you have put in
Additional costs associated with insurance policies (e.g. cost of insurance, distribution cost, etc), are usually higher than with other equity investment options
Reinvestment risk and cost. This is especially so in cases where a huge lump sum is paid out upon maturity and the full amount is not used immediately, such that you may seek to reinvest it (with brings additional new costs).
