Life annuities provide a guaranteed income from your pension. But guarantees do not come free. Ultimately, this type of pension rarely pays off.
by UBS Insights
19 Apr 2019
An annuity is a form of insurance policy. You make either staggered contributions or pay a one-off amount and get a guaranteed, regular payout in your old age. How you pay in and receive the payments is laid out in advance in a contract.
Just like with a conventional insurance package, the payouts are based not just on the premiums paid but also on what payments are stipulated in the agreement. Thus, annuities can guarantee a fixed income right up to advanced old age and even pay out more in total than you paid in. At first glance a good thing.
You will rarely get more out than you paid in
On closer inspection, it quickly becomes clear that providers make their calculations very carefully. This means you really have to live a long time for the policy to pay out more than you actually paid in. In addition, annuities are not very tax-efficient. It is true that, unlike the AHV or pension funds, only 40 percent of an annuity pension is subject to income tax.
However, this is not a tax break, even if it may look like one at first. This is because the 40 percent figure applies not just to the surplus annuity but also to the reduction in capital as you draw your pension. Given that the capital, i.e., the original payments to the fund, is generally financed out of your income and therefore has already been taxed, this amounts to double taxation.
If, on the other hand, you create your own savings plan and generate income from it later, the capital attrition is not taxed. For tax purposes, the calculated and gradual consumption of capital is therefore more attractive.
Security – at a price
Annuities are less flexible, involve certain tax drawbacks and only rarely pay out more than you paid in. They do, of course, offer a guaranteed income, but this comes at a price and the same result can often be achieved in other ways, for example by taking out specialist risk insurance policies. Before signing an annuity policy, it is certainly worth considering the alternatives very carefully.