21 November 2011

How to Evaluate Retirement Annuity Plan

Retirement planning is one of the often overlooked aspect in personal finance. By the time one realizes the significance of a retirement plan, he usually discovers that there are only a few years left to retirement age. The primary focus for the years which has passed by had been on children education fund and settlement of debts or mortgage.

In budget 2012, there is this new RM 3,000 tax relief (previously RM 1,000) on contributions to private retirement scheme and insurance annuity for 10 years. This tax relief shows that the government started to recognize the importance of insurance annuity as retirement income because lump sum retirement savings such as EPF, more often that not, gets exhausted too soon.

There are certainly hybrids of insurance plus retirement savings plan in the market, but pure insurance annuity plans are certainly not very popular here. However, with this tax relief, banks or insurance companies might come up with new structured products to offer to customers.

A friend of mine went to her bank recently. This is what the financial advisor proposed to her:

Contribute RM 500 per month for 15 years, and then from 16th years onwards, get paid RM 4,000 annually until age 75, with additional guaranteed maturity bonus of RM 73,000.

The plan is also pretty "inflexible" as you are not allowed "redeem" your paid premium for the first 15 years in case of any financial emergency.

It is likely that most people will adopt a simplistic approach to calculate the return of this retirement annuity plan, assuming current age is 30 years.

Disregarding the time value of money, for a total invested amount of RM (500 x 12 x 15) = RM 90,000, you get back RM (4,000 x 30 + 73,000) = RM 193,000. Your response: 90k over 193k is a 46.6% return!

Yes, 46.6% return in 45 years. You got to be kidding me.

Here's the correct way to calculate your return for this type of deferred annuity, using Internal Rate of Return (IRR) in Microsoft Excel. I will guide you through step by step.

a) Type "n-th Year" in Column A, Row 1.
b) Type "Cash Flow" in Column B, Row 1.
c) Enter "1" in Column A, Row 2.
d) Enter "2" in Column A, Row 2 and all the way to "45".
e) Enter "-6000" in Column B, Row 2 and all the way till Row 16.
f) Enter "4000" in Column B, Row 17 and all the way till "n-th Year" equates "45"

It should look something like the table on the left.

In any empty cell, type this formula: "=IRR(B2:B46,0.03)"

Select this cell, right click > "Format Cells..." > "Number" tab > "Percentage"
Change decimal places to "2"

You should get IRR = 2.89%

This means, the annualized effective compounded interest rate of return of this plan over the 45 years period is 2.89%.

Another way to put it:
The return per annum of your total cash inflows over your total cash outflows is 2.89 percent.

Ponder over this alternative:
The monetary return will be more than the aforementioned annuity plan if today, a risk averse person locks RM 90,000 into a FD account with a constant interest rate of 3% for the next 45 years.

Dear readers,
Do you think that annuity plans are for those who are not sufficiently disciplined to manage their own expenses and investment?
If you have similar plan being offered to you by your insurance agent or banks, do let me know the details by leaving a comment below or at my Facebook page. We can analyze your case for the benefit of the masses.


  1. Yes. I have seen alot of these type of products. They are even more fancier type of products than your example.

    But upon calculation, the real returns per years can barely beat the FD rates.

    Better to wait for the Sukuk bonds. I am suspecting that it will come soon as the Govt needs some money from the rakyat the current economy and the hoohah development plans which we don't really have the money for :P


  2. I agree. I simplified it for simplicity purpose :). Mind to share w/ me the more fancier type?
    When the Sukuk bonds come out, be sure to blog it; I am interested too. Sounds that from your experience Sukuk bonds are pretty positive.


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