# How does an annuity work?



## westcork (15 Sep 2011)

Did a trawl through some of the posts and could not find a basic answer - According to the paper today, €100k in your pension pot will realise an annuity funding a pension of €5,400 pa if you retire at 65.

Once you die is that it for the money? It seems nuts to buy an annuity or am I missing something??

Average life expectancy in Ireland for a male is 76 - retire at 65 = 11 years * 5,400 = 60k! You lost out on 40k. Lets say you live to 85, your still only getting 108k back on your original 100k

Does it not just make more sense to invest the 100k in a high interest deposit account and draw down 5,400 per year - by my reckoning you will get much more out and if you pop your clogs early you have an asset to leave your family - Or am I missing something?


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## boaber (15 Sep 2011)

A member of a DC Occupational pension now has the option of putting the balance of their fund after tax free lump sum into an AMRF/ARF rather than an annuity.  On your death the AMRF/ARF can be transferred to your spouse.

Due to Revenue rules, it is unlikely that you would be able to withdraw the full €100K (assuming this is thae amount after taking a tax free lump sum) without some or all of it being subject to PAYE, therefore you wouldn't have €100K to invest in a deposit account.


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## Baracuda (15 Sep 2011)

Some of the figures that were quoted from the paper are wrong and as a result your calculations are out, may I explain; 

The life expectancy for all males in our population is about 76 or 78 depending on which body is publishing the information. A man that has reached the age of 65 can however expect to live for a further 16.7 years (source pension board national pension review Oct 05 chapter 5.2) This is also expected to increase with medical advances in the coming years. IMO I would think that people that have pension benefits would also live longer than this average as they would be able to afford private medical insurance, nursing home care, would not suffer from fuel poverty etc etc. So based on this the figures that were quoted are way out and its just the media massaging the figures to sell a story!!!

Reasons that annuities are so low is that the life company must secure pension payments against AAA rated bonds which have always produced very low returns. Even at the moment when financial markets are extreamly turbulant German AAA rated bonds are only returning c. 2.9%. The next reason is that the life company has to administer the annuity for an average of 17 years, this would include posting out a monthly cheque, PAYE administration costs etc etc. Next reason is that there is a commision that would have to be paid to the advisor.

With regard to the pension dying with person, One of the life companies have a product called "Investment Protection" This has a lower annuity rate but it pays out the any remaining fund when the person die's e.g. Fund value of 100,000, person receives annuity payment of 4500 p.a. person die's after 10 years Total payments received 45,000 Life company pays remaining 55,000 to the persons estate. IMO this is the best option. This only became available to DC Occ members as a result of Finance Act 2011 as annuity is set up under ARF rules.

It a person only had 100,000 pension fund they would more than likely have to buy an AMRF which cannot be surrendered before age 75. They can however take any growth from the fund providing that they maintain the original investment amount. 

So if you invested 100,000 in a AMRF fund in the best deposit account today, you would expect a return of about 4%, AMC would be about 1% so the most that you would be able to take out at age 65 would be about 3000. Now that's fine today when interest rates are at this level but remember only a short few years ago when you would be luckly to get maybe 0.75% p.a. 

I do see your point and I do agree with you in certain cases, but in reality  retired people require a guaranteed income and are quite happy to go down the annuity road. I have seen people going down the ARF road and have taken quite large % out of their funds in the first few years and are now living quite meagrely as a result, because their funds have been heavily depleted.


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## DerKaiser (16 Sep 2011)

westcork said:


> Does it not just make more sense to invest the 100k in a high interest deposit account and draw down 5,400 per year - by my reckoning you will get much more out and if you pop your clogs early you have an asset to leave your family - Or am I missing something?



The vast majority of people buying annuities are those obliged to because they took out a pension and got tax relief.  There is not many people who walk in off the street with non-pensions savings to buy an annuity.

As Barracuda has said, the interest rate is based on very low yields at the moment (less than 3%) on very secure investments.  Comparing them to the 4%+ returns from less secure Irish bank deposits is not appropriate.

Finally, the principle of the annuity is that you have enough income to live on whether you die early or live longer than expected. People often get hung up risk is of dying early. A far worse risk would be living longer and have used up all your savings when you need them most for nursing home care, etc.


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## cantthinkof1 (26 Oct 2011)

Hi, I have a question that I think ties into OP. Sorry if its off topic.

I have a friend, Widow for 10+ years, that has a pension maturing that her husband took out. 
She has been told she has 125,000 lump some or 6,000 per year annuity and is unsure which option to choose. 

Would she be taxed on the lump sum? (And at what rate)
She has no other income other than her widows pension at present

Really appreciate any advice


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