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Posts Tagged ‘expected investment returns’

What price income protection? Or the cost of an annuity

In Investments on 02/12/2009 at 11:09 am

I was reading an article describing how much a 21-year old and  a 40-year-old man or woman would require to set aside to get an annual income equivalent to the median annual earnings in the UK. (“If you line up all the workers in the UK, from the highest earners and one end to the lowest at the other, and pick the person exactly in the middle – that is the median.”)

Data was provided by an insurer and a fund manager. The insurer calculated on the basis of the lump sum needed to buy a annuity; while the fund manager calculated on the assumption of expected investment returns if a lump sum was invested.

I tabulated the numbers in a table and in the last column calculated the differential in percentage terms using “Investment Cost” as the denominator.

DESCRIPTION EARLY RETIREMENT COST (using Annuity) INVESTMENT COST PERCENTAGE DIFFERENCE
Man aged 21 £2,019,117 £807,245 149
Man aged 40 £1,268,780 £659,248 92
Woman aged 21 £1,658,201 £666,076 148
Woman aged 40 £1,069,225 £554,676 95
Assumptions An estimated inflation rate of 3% a year. Take into account tax that would have to be paid. An average annual growth rate of 5% in these investments and inflation of 3%.  
Source Canada Life Fidelity International  

The differential surprised me. I know, I know: the annuity payments are assured, annual investment returns are not, and can be volatile. The investment principal could be depleted. And yields on long-term government paper, that the insurer would invest in to pay the annuities, are pathetic. But still ….  And BTW an annuity stops paying on death. Investments can be inherited.

And this in a country where the annuity market is very developed. Imagine the premium in Singapore where the annuity market is not as developed as that of the UK.  By any measure, the annuity market here is third world.

FYI, a friend is trying to provide me with local data so that I can localise the comparison. (Update on 14/1/2010, no gd local data to work on.)

Still the above table shows that the price of an assured life-time income is very high.

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