I did some sums recently and concluded that charges by advisers and insurance companies eat up more than a quarter of each year's income withdrawal for many, probably most, of their clients. It's far more than 25% in many cases. That level of fee extraction is unconscionable
This is the essential difference between an annuity and an ARF. Unfortunately it gets masked by lots of other differences such as advisory costs, inflation, capital costs, guarantee costs etc,Any analysis must also consider the mortality cross subsidy that exists in annuities compared to an ARF.
Risk of losing money | Annuity | ARF |
Interest Rate Risk | High at point of purchase | |
Inflation Risk | High | |
Early Death Risk | High | |
Long Life Risk | High | |
Market Risk | High | |
Bankruptcy Risk | Med | |
Risk of Variable Income | High |
Well produced, but...extremely tendentious.A Timely video here, discussing this very topic by Malone Financial
Annuity or ARF | Which Is Best For Retirement?
In this video, we're talking about whether choosing an annuity or an approved retirement fund (ARF) is the best option for retirement. When an individual rea...www.youtube.com
I'm no expert with either of these but this is my attempt to compare the risks
Risk of losing money Annuity ARF Interest Rate Risk High at point of purchase - I would recommend deferring annuity purchase till about 75 when the mortality subsidy outweighs this factor. Inflation Risk High - if you don't buy inflation protection Med - 9% inflation last year; markets moved sideways Early Death Risk High - a risk to your dependents not you Long Life Risk High Market Risk High - well an ARF doesn't have to invest in risk assets though that is the usual recommendation Bankruptcy Risk Med Not applicable - both rank equally on wind-up Risk of Variable Income High
ARF inflation risk is high.Thanks Duke, some nice nuance there.
However ARF inflation risk is not High. Yes in any given year the markets are not going to compensate you for inflation, but over the course of your 30+ year retirement they certainly will.
Okay, I have adjusted the risk to Medium. Clearly equity investment has more potential inflation protection than fixed rate annuities. But I agree with @Marc that this is much less perfect than the likes of Malone Financial portray.Thanks Duke, some nice nuance there.
However ARF inflation risk is not High. Yes in any given year the markets are not going to compensate you for inflation, but over the course of your 30+ year retirement they certainly will.
I don't believe there's anything tendentious about my points. Globally, annuities are well recognized as being sub-par options for retirees as compared to continuous investment in retirement. But you're entitled to your opinion of course! To address your points:Well produced, but...extremely tendentious.
When an annuitant dies the life company does not pocket your money, the surviving annuitants do.
Annuities enjoy tax free interest in the same way as ARFs.
Compound interest is a red herring (sounds clever though). Deemed Distribution killed any advantage of compound interest - the dividends in the ARF fund would need to exceed the DD before they could be reinvested.
The reality is that as a group ARF holders only enjoy about half their hard earned and saved funds - their relatives enjoy the other half. As a group annuitants can enjoy all of their HESF. ARFs are best for people who are in the position that they have no risk of outliving their savings - in reality all investment decisions are inheritance planning. For those who are likely to need most of those savings at least contingently; (realistically priced) annuities are probably better.
As for life companies ripping off annuitants it is well known that the financial intermediation costs of ARFs are in fact far higher. Malone doesn't mention this.
- This isn't correct. Standard annuities die with the annuitant. Yes, you can purchase a reversion on your annuity which will typically pay 50% of the annual annuity payment to the surviving spouse - but the lump sum is gone. That reversion comes at a cost. The cost being a lower annuity rate (a differential of ~70bps as per Irish Life). Nothing is free with annuities (inflation protection, minimum guarantee periods etc.)When an annuitant dies the life company does not pocket your money, the surviving annuitants do
- What tax-free interest are your referring to? Annuity income is subject to income tax and USC where applicable. Investment income and gains from ARF investments are exempt from tax. It's only when you withdraw from the ARF that the funds are liable to tax (aside from the imputed distribution where annual withdrawals are insufficient).Annuities enjoy tax free interest in the same way as ARFs
- Compound interest is most certainly not a red herring. ARF holders are required to withdraw a minimum of 4% p.a to age 70 and 5% thereafter. It's more than feasible to achieve an investment return within the fund that counteracts this effect (thus enabling compound interest). Plus, the dividends and gains are tax free, making this even more feasible. Just depends on what you're investing in.Compound interest is a red herring (sounds clever though). Deemed Distribution killed any advantage of compound interest - the dividends in the ARF fund would need to exceed the DD before they could be reinvested
- Not sure I follow this logic. Feel free to expand.The reality is that as a group ARF holders only enjoy about half their hard earned and saved funds - their relatives enjoy the other half. As a group annuitants can enjoy all of their HESF
- Sure, you're always going to have fees, this is Ireland. However, I'd much rather be paying IM fees and for my funds to be enjoying tax-free investment growth throughout retirement than to fork over the whole lump sum to a life company and have no chance of capital appreciation or income growth (with the exception of the annuity escalation option which, again, comes at a lower annuity rate)As for life companies ripping off annuitants it is well known that the financial intermediation costs of ARFs are in fact far higher.
This is a hugely underestimated risk of ARFs, IMO, and should really be highlighted in the above chart.Taking on more risk assets to try and compensate for inflation risk also exposes the ARF to sequence of return risk and this is especially damaging in the early years.
ARF inflation risk is not high (or even Med Duke). Your conflating 2 different things, market risk and inflation risk.ARF inflation risk is high.
Investing an ARF in risk assets does not guarantee a real return. Equites went sideways for 14 years in the 70s and early 80s.
Very true. Sequence return risk IMO is actually the main risk for ARF holders. Probably deserving of a thread all on its own.Taking on more risk assets to try and compensate for inflation risk also exposes the ARF to sequence of return risk and this is especially damaging in the early years.
ARF inflation risk is not high. Your conflating 2 different things, market risk and inflation risk
Ahh, I think you and I are making 2 different assumptions here. You (if I'm interpreting correctly) are coming from the point of view that purchaser is using market risk to compensate for inflation risk. I would guess in your professional background you come across this.In seeking to attempt to keep up with inflation, market risk can unsettle an ARF strategy to such an extent that some retirees and those with long lives in particular may find that they were better off buying an annuity for some or perhaps all of their pension.
When an annuitant dies the life company does not pocket your money, the surviving annuitants do.
This isn't correct. Standard annuities die with the annuitant.
Annuities enjoy tax free interest in the same way as ARFs.
What tax-free interest are your referring to?
Welcome to AAM. By "tendentious" I mean with an unjustified bias, which I will elaborate on in further answers to your points below. I do not mean it in any personal pejorative sense. BTW liked your video clipI don't believe there's anything tendentious about my points.
They certainly were during the QE period. There are dysfunctional aspects to the annuity market. I remember a long time ago life insurance companies backed their annuity books at least partially with equities. These days, Solvency II has been a big drag on annuity pricing forcing companies into gilts and to provide for 1/200 risks like longevity improvements. That's why I am suggesting state backed inflation linked annuities for the AE initiative.Globally, annuities are well recognized as being sub-par options for retirees as compared to continuous investment in retirement.
@AAAContributor has corrected you on this point. It really is rather basic.Standard annuities die with the annuitant.
Sorry, I don't see the relevance. There are no free lunches in this world either with annuities or ARFs.Yes, you can purchase a reversion on your annuity which will typically pay 50% of the annual annuity payment to the surviving spouse - but the lump sum is gone. That reversion comes at a cost. The cost being a lower annuity rate (a differential of ~70bps as per Irish Life). Nothing is free with annuities (inflation protection, minimum guarantee periods etc.)
Another rather basic error. Annuity income is only subject to tax when it is received by the annuitant - just like with an ARF. Within the life company the investment return is tax free.- What tax-free interest are your referring to? Annuity income is subject to income tax and USC where applicable. Investment income and gains from ARF investments are exempt from tax. It's only when you withdraw from the ARF that the funds are liable to tax (aside from the imputed distribution where annual withdrawals are insufficient).
I hate to say it but you are compounding (see what I did there) the previous error. The investment income backing an annuity within the life company is totally tax free and will compound (if it is not distributed). This is exactly the same as with an ARF. With a level annuity the distribution (annuity payment) will always be higher than the investment income and so compounding does not arise. With an inflation linked annuity the opposite situation will hold initially and compounding will occur. With an ARF if the investment income exceeds the deemed distribution, yes there will be compounding. This might be achieved by investing in high dividend stocks. There is no difference in tax treatment between the two.- Compound interest is most certainly not a red herring. ARF holders are required to withdraw a minimum of 4% p.a to age 70 and 5% thereafter. It's more than feasible to achieve an investment return within the fund that counteracts this effect (thus enabling compound interest). Plus, the dividends and gains are tax free, making this even more feasible. Just depends on what you're investing in.
Sorry, but I hope I have convinced you that this is no different than with an annuity. Let me illustrate.- Sure, you're always going to have fees, this is Ireland. However, I'd much rather be paying IM fees and for my funds to be enjoying tax-free investment growth throughout retirement
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