Pensioners opting for annuity in place of programmed withdrawals; the truth about annuity they do not know.

At our pension fund, we receive quite a copious amount of applications for annuity each day. Although this is detrimental to the business, we have no choice but to grant the retirees’ request because they have a right to choose either a programmed withdrawal (ie monthly payment of pension benefits until around 30 years) or an annuity (monthly payment, but usually way higher than the programmed withdrawal).

The reason for an annuity being detrimental to a pension fund is that on request by the retiree for an annuity, the pension fund after receiving approval from pencom must transfer the account balance to the desired insurance company chosen by the soon to be annuitant. Annuity represents a huge outflow to the pension fund, and therefore reduces the asset under management and in so doing the ability of the pension fund to generate higher returns.

A programmed withdrawal works this way: when a retiree resigns or is sacked, and the official age i.e the age confirmed by his employer on the employer confirmation letter is up to or above 50 years of age, the pension fund pays him a lump sum of the total amount in his RSA (Retirement Savings account), and then amortizes the remaining to be paid monthly for about 30 – 34 years. The pension fund prepares a template which the retiree is required to sign if he or she accepts the terms. The template carries details of the lumpsum to be paid and the computation of monthly payments. The lump sum is paid regardless of the retiree choosing programmed withdrawal or annuity. The retiree then has the option of ticking  a programmed withdrawal or an annuity on the template.

If the retiree ticks the programmed withdrawal box on the template, and signs, we carry on our business by paying the lump sum into the retirees account. After making the lumpsum payment, we immediately start making the monthly payments. If on the other hand the retiree ticks the annuity box, then he has to send in an application for the stoppage of his programmed withdrawal and application for annuity. The two requests can be conveyed in one letter.

After this, we give the retiree the balance in his account, which he must use to draw up an annuity agreement with his insurance company. Immediately a retiree applies for annuity, we put a stop to his monthly programmed withdrawal, and on receiving the necessary documents, we prepare the application and send it to our national regulatory body (pencom) for approval. It should be noted that on receiving the annuity application and the application for the stoppage of programmed withdrawal, the pension fund immediately stops paying you your monthly benefits because the remaining amount in your RSA is immediately processed to be transferred to the Insurance company the retiree opts for.

I am writing this post to educate retirees on what an annuity is, the advantage of an annuity and some hidden secrets the insurance company doesn’t share with you when drawing up the annuity agreement. Let us first begin with what an annuity is. An annuity is a contract between an individual and an insurance company where the insured pays the insurance company a lump sum premium in exchange for guaranteed streams of income on retirement. The insurance company promises to pay the annuitant a fixed sum at periodic intervals, usually as long as the life span of the person, or in some cases for an agreed period predetermined by the insurance company.

In Nigeria, life time annuities are entered usually after a person retires and reaches the age of 50 years. The annuity agreement is entered into by making a single payment or a lump sum payment; but in other countries such as USA, an annuity might be purchased with an initial deposit and then subsequent contributions within an agreed period. Some of the reasons why people opt for annuity are that their money or assets would be managed by professionals who have the ability to generate higher returns than they could ever have, and it also prevents the lavish spending and mismanagement of funds as commitments are made in the form of deposit of lump sums at the beginning of the contract.

To really have an in depth understanding of annuity, let us define some key terms in annuity.

• Annuity: This is a contract entered into between an annuitant and an insurance company which involves the purchase of a premium by the annuitant in exchange for a guaranteed fixed sum at periodic intervals for life or for some predetermined number of years.

• Annuitant: This is the person to receive the annuity payment. He is usually the person who signs up for the annuity, but in some cases, an annuity can be made on behalf of another person.

• Deferred annuity: This is an annuity that provides guaranteed income at a future date. A deferred annuity can be further broken down into a deferred fixed annuity and a deferred variable deferred.

1. Deferred fixed annuity: This offers a guaranteed minimum interest rate for the life of the contract. In Nigeria for example, most of the annuity agreements I have seen would guaranty an interest rate and periodic payment for a period of 120 months (10 years), and then after the initial guaranteed period expires, a renewal rate would be declared by the insurance company.

1. Deferred variable annuity: In a deferred variable annuity, your investment or contributions are managed by professional money managers. They invest in a range of investment options or asset classes. You are given the opportunity to choose from the available investment options, and at the end of the day, the value you receive would depend on the performance of the investment option you choose.

• Accumulation period: This is the period in which funds are built up for a deferred annuity. It is the period at which an annuitant contributes to his annuity and builds up the value of his annuity.

• Loads: These are fees payable on the purchase of an annuity.

• Payout Phase: This is the period where you begin to receive payments from your annuity account

• Principal: This is the amount used to purchase the annuity. In order words, it is the balance of your annuity account excluding any interest or returns the annuity might have gained.

• Single life annuity: Annuity that covers payments when the annuitant is alive. The annuity is not transferable to a beneficiary, and monthly payment ceases when the annuitant dies.

Hello people, it has been brought to my attention that the annuity landscape in Nigeria has changed so the explanation highlighted in red below is not valid. Apparently, after drafting this post, annuities started being heavily regulated by the National Insurance Commission (NAICOM) and Pension Commission (Pencom) but since i left the pension industry shortly after, i was not aware. A document containing regulations that would govern the conduct of the annuity business in Nigeria was jointly issued by Naicom and Pencom.

As at August 2017,  National Pension Commission (PenCom) had given approval to nine of the 26 life insurance companies to take fresh annuity business in the country. The approved firms are AIICO PLC, Custodian Life Limited, FBN Insurance Limited, Leadway Assurance Limited, Cornerstone Insurance Plc, ARM Life, AXA Mansard Insurance Plc, Standard Alliance Insurance Plc and Niger Insurance Plc.  As at now, the cumulative annuity funds in Nigeria has risen to N170billion, this is still considerably low considering Stanbic IBTC has over 1.4trillion naira AUM. Nonetheless, a lot of retirees are option for this option as a result of more favourable terms and conditions.

So my dear readers, the ball is in your court, Annuities and Programmed withdrawals are both regulated by Pencom now, so there is no reason to fear. Also, news reaching me is that annuity guarantees payment of the initial high monthly payment for life. So for now, it would just depend on your preference and who you think would generate more returns for you. Personally i am tilting more towards annuity for now,  as on retirement your fund is moved to retirees fund under pension scheme and the returns it would command may be lower as the cumulative funds in the retiree fund account can’t match that in the RSA fund account of the same pension fund (This is because there are more people currently working than retired).  Also, pension funds tend to be more conservative with retirees funds. Annuity on the other hand will not separate funds, and it may be able to command higher returns in the market.

Below is the previous post (highlighted in red) i drafted back when i was a corper at a pension fund (2015). Kindly note that it is not valid anymore. Just thought to leave it else there would be no need for this post. Many thanks to my esteemed reader who reached out to me on Whatsapp regarding the validity of this post.

Now that we have discussed what an annuity is, and also looked at some key terms in an annuity, lets us see why many retirees are migrating to annuity. The main reason for a shift to annuity from the original programmed withdrawal is that the monthly payment of annuity in Nigeria is higher than that of a programmed withdrawal. It is usually around 25 to 30% higher. This is because the high monthly payment is guaranteed for a period of 10 years, after which if the retiree is still alive, payments after the 10^th year would be significantly lower. A programmed withdrawal by a pension fund administrator on the other hand pays you a fixed amount for a period of 32 years for men and 34 years for women.

Another benefit of the programmed withdrawal over the annuity in Nigeria is that in an annuity, if the annuitant dies after the guaranteed period (10 years), relatives or Next of kins do not receive any further payment while on the passing away of a retiree under the programmed withdrawal, relatives of the deceased can immediately file for the balance of the retiree’s account, with payments being made in the form of death benefits.

An annuity in Nigeria is not void of its benefits too, because in a situation whereby a retiree is sacked, above the age of 50, and bubbling with business ideas, he can quickly move to an annuity and the higher payments received from the annuity can be used to fund his growing business.

Choosing between an annuity and a programmed withdrawal should depend on your liquidity preference. Do you need more for a shorter period of time, or do you need a little less for a longer period of time?

Recommended Reading

Moshe A. Milevsky., Life Annuities: An Optimal Product for Retirement Income