Saving money for your pension
In countries such as the United States and the United Kingdom where a state pension (first pillar) does not provide sufficient retirement income, private pension saving plans are very common. In countries where the first pillar is very present, this practice is less widespread. However, even in those - mainly European - countries, an increasing number of young people are starting to save money for their old days, on the one hand because they are afraid that the State, unable to face up to the ageing of the population, will not be in a position to fulfil its commitments, and on the other hand because they want to benefit from the tax incentives associated to private saving plans.
Our savings know two key periods: accumulation and decumulation. During the accumulation period, you save money so you can maintain an acceptable lifestyle after you retire. The decumulation period starts from the moment you retire and consists in living thanks to the capital you have saved during your working life.
At the end of the accumulation period, you can decide to receive your benefit in one time or you can choose to receive periodic payments (mostly called ‘annuities’).
The annuity, a "longevity" insurance
The annuity consists in receiving every year a portion of the savings you have accumulated. In this sense, you can say it is a ‘longevity’ insurance.
An annuity is also a kind of insurance that protects you from spending all your savings during your old age. It prevents you to spend all your money during your early retirement because you would be « blinded » by all the money you have just received and/or by lack of information regarding inflation issues and life expectancy.
The annuity as insurance product
There are three types of annuities available:
- Conventional annuity (or constant annuity),
- Scheduled redemption plan,
- Variable annuity.
In case of a conventional annuity, you are free to choose your saving product during the accumulation period. The annuity only intervenes at the end of the accumulation period and allows you to transform the accumulated capital into a constant annuity. The advantage of this product consists in the fact that you can benefit until the end of your life of a fixed income. However, the conventional annuity is a « pure » life product. This implies that in case of death, your capital is lost and cannot be transmitted to your heirs, which is the main weak spot of this product type.
Via a scheduled redemption planyou receive at regular periods during the decumulation period, a portion of the value you acquired through your life insurance contract. In order to do so, the saving product must be a life-insurance product. The advantage of this product is that you can choose the life-insurance product that best meets your needs (high risk vs low risk). Moreover, this type of product allows to transmit the balance of your capital to your heirs. However, the redemption amount nor the duration can be anticipated just because they depend on the value of the life-insurance contract (which can fluctuate in case of unit-linked contracts, for instance). Moreover, the redemption plan stops once the value of the life-insurance contracts equals zero.
Variable annuity combines the advantages of both products mentioned above while strongly reducing their disadvantages. Indeed, with variable annuities, you stay the owner of the capital. This implies that in case of death, the variable annuity allows to transmit what is left of your capital to your heirs. Besides this, you can select yourself the product type in which you want to invest your savings (high risk vs low risk). And last but not least, a minimum amount of fixed income will be guaranteed until your death (« Guaranteed Minimum Withdrawal Benefits »). Moreover, the variable annuity allows you to benefit, not only of a minimum fixed annuity, but even of a higher annuity if the product in which you invested performs well.
If you want to find out more about the BSB offer with regard to variable annuities, click here.
Variable annuities… How does it work ?
Without going into details, it implies that the saver who takes out a variable annuity, invests his capital in a fund (Open end investment company). He can make a selection within a large range of funds, with all different risk levels. According to the selected risk level as well as someone’s age, a conversion factor will be applied allowing to calculate the minimum annuity that the person will receive until his death.
Let’s take the fictitious example of a 50 year old person who wants to invest 100.000 euros in a low risk fund, to which a conversion rate of 3% will be applied. This person will receive at least 3.000 euros a year until his death. The mechanism is the following: the 100.000 euros are invested in the fund he selected and each year, an amount of 3.000 euros (including management charges) will be withheld of this fund.
Other simplified example: a fund having a 0% performance (with an inflation rate also equal to 0%). If the person dies at age 60 (10 years after having taken out his variable annuity), there will be about 70.000 euros remaining in the fund which can be recovered by his heirs. But if he lives until age 100, the value of this fund will be 0 starting from age 83, but this person will keep on receiving his 3.000 euros per year. This is called a « Guaranteed Minimum Withdrawal Benefit ».
Let’s take now the example of a fund of which the value collapses due to an important financial crisis. However the value of the fund is near to 0, the person who has taken out the variable annuity will continue to receive his 3.000 euros per year for life.
Finally, let’s take the example of a high yield fund. In this case, the person who has taken out the variable annuity has two options: whether he withholds his capital gain (by surrendering it), whether he transforms his capital gain into a higher annuity. If he chooses this last option, a ‘click’ system will be put in place, which means that the new annuity amount (3.500 euros for instance) will be fixed for life.
The future of the variable annuity
Although the fist pillar is very present in most of the European countries, more and more people are starting to save money for their old days, because they are afraid that the State, unable to face up to the ageing of the population, will not be in a position to fulfil its commitments.
Most of these people will prefer an annuity to a unique capital, mainly due to its ‘longevity’ aspect. Finally, according to our business experts, of all the yield products, the variable annuity is the most interesting one as it combines several advantages. It will surely become one of the basic products for private pension savings !
If you want to find out more about the BSB offer with regard to variable annuities, click here.
