What is available?
A reader sent me this article about an annuity product on Monday and asked for my reaction.
I'm not too familiar with the annuity market here in Japan, so I thought this might be a good chance to take a look at what an annuity is, how to think about them, and of course to discuss the specific product our reader was asking about.
What is an annuity?
An annuity is a form of insurance against living too long. It's a promise to pay you a certain amount of money until you die.
A state pension is a type of annuity (maybe one of the best types, as it is guaranteed by a government and not a private company). This is why paying into the Japanese national pension or the UK pension can be a good idea.
You generally buy an annuity by paying a certain amount of money in exchange for regular payments. If you don't live very long, you lose out as you won't claim as much money as you paid. If you live for a long time, however, you can receive more money than you paid and most importantly you never run out of money.
What types of annuity are there?
There are many types. Typical variations include whether the annuity increases with inflation or not, whether your spouse can continue receiving it if you die first, and when the payments start. These factors make the annuity more or less expensive.
How should we think about annuities?
An annuity can be used to establish an income floor for your retirement. Together with any pensions, annuities can provide a minimum income that will hopefully meet your basic needs. This post explains the concept very well.
Another advantage of annuities is that they are a form of dementia insurance. It is quite possible that we will become unable to look after our investments in old age, becoming vulnerable to mistakes in judgement or fraud. An annuity can eliminate this risk by providing you a regular income regardless of what you do.
How about the product in the article?
The article describes a whole life annuity offered by Sumitomo Mitsui Banking Corp. The example given is a person who buys the annuity at age 60, then begins to receive payments in US dollars at age 70. The product yields 3%, so to break even the customer would have to live to 83 or 84 years old.
To make it sound more attractive, the article compares this to just keeping savings in cash and taking out a certain amount every month. I don't believe this is a very useful comparison.
There are several problems with the product as written:
- It is denominated in US dollars, exposing the customer to exchange rate risk (if the yen gets stronger the payments will be worth less). Annuities are supposed to provide reliable income so this is not ideal.
- The payments start ten years after handing over the cash. Some people will die before receiving a penny, and their families will lose out. Also, given historical rates of return you could expect a balanced stock portfolio to double over ten years.
- The 3% yield is at the lower end of safe withdrawal rates (the amount you should be able to take out of a stock/bond portfolio without running out of money). Even keeping your money in cash and taking out 3% a year would give you 33 years of payments so again this does not seem particularly attractive.
I think there can be a place for annuities in retirement planning, but this product does not seem fit for purpose. Anyone who is willing to learn a bit about investing should be able to do better by investing in a simple portfolio, particularly if they use their iDeCo and NISA allowances.
What do you think? Are there any other examples of annuities in Japan? Anything worth looking at?