ANNUITIES, or longevity insurance, is a hot topic now, thanks to Prime Minister Lee Hsien Loong's mention in last week's National Day Rally speech.

Last week, Dr Money answered some basic questions on annuities in general. Today, he addresses some specific concerns on the CPF annuities scheme:

Do I take a risk when I buy an annuity?

Yes, in a way. An annuity is the opposite of life insurance - you receive payouts when you live rather than when you die.

It is the proper insurance for when you no longer draw an income.

When you stop working, your goal is to insure against outliving your money.

This is what an annuity does.

How does it work under the CPF scheme?

Under the new scheme, all CPF members will buy an annuity at age 55 using money from their retirement account.

You will receive payouts from age 85.

Three things keep costs low:

- the annuity kicks in late in life, at 85,

- it provides for only a subsistence payout of around $300 per month and,

- the default option is your beneficiaries don't get a refund if you die early.

Shouldn't my beneficiaries get the balance of my annuity if I die before age 85?

Let's call it 'money back' or MB if the unpaid balance of your annuity is returned to your beneficiaries.

At first glance, this seems to be the better deal.

It's not, however, since the refund feature in MB comes at a financial cost.

Let's call the other choice, 'no money back' or NO MB.

If you die early, your remaining annuity stays in the common pool.

It is used to pay those over 85 who are still alive. This reduces the costs for all.

It's your choice: Pay a high price for MB or a low price for NO MB. Either way is fair.

Between the two, which is better?

Since both are fair, it depends on your preferences. Mine is NO MB since it is cheaper.

It is likely to be the default option for the new annuity at age 85. Those who prefer, however, can buy the more expensive MB annuity.

Since the new annuity offers a choice, it seems possible that the CPF Board may want to rethink its policy of permitting only the expensive MB type for current annuities.

These let you use your retirement account to buy an annuity from insurance companies with payouts from age 62 until death. If you die early, the balance goes to your beneficiaries.

They are not very popular and only about 4 percent of people over 55 select them. The other 96 per cent take the CPF Board's default option of a 20-year payout from age 62 to 82.

By 2018, the payout period will increase to be from age 65 to 85. But even then, more than half will still be alive at age 85 when their money runs out. Then, at age 85, the new subsistence annuity kicks in.

If the CPF Board were to permit NO MB, the lifetime annuities would be cheaper, and their popularity might increase.

If I buy term life insurance, my family gets money if I die. With the longevity insurance (annuity), my family loses money when I die. It doesn't seem right.

It looks contradictory. But it's not. Both reduce risk.

When you are working, your family loses income if you die. Term insurance protects against this risk.

When you are no longer working, you run the risk of outliving your money. Longevity insurance protects against this.

The contradiction is resolved when you see the risks are different at different stages of your life. Both types of insurance - term and longevity - reduce risk.

--------------------------------------------------------------------------------

More CPF schemes to protect you

ANNUITIES do a good job eliminating the risk of outliving your money.

But how about other risks, like making wrong investments, especially when you are young?

You may think: 'I have no dependants. I'll use my CPF money to contra trade or buy penny stocks.'

Not only that, even so-called 'safe' investments like unit trusts and (investment-linked products) ILPs, with initial commissions, expense ratios and hidden expenses make it hard to earn a decent return.

Taking losses is hard, and it is worse if you don't have much money in the first place.

These investment risks are reduced by another new CPF rule: You can make investments from your ordinary account (OA) only after setting aside $20,000.

The first $20,000 in your OA can be used for housing and other purposes, but not for investments.

It defers risky and tricky investments until you can afford the risk of loss - after you have accumulated a bit of wealth.

Is this article useful to you?