Home' Trinidad and Tobago Guardian : April 26th 2015 Contents Client Situation
Martha, 49, is an account-
ant with a local auditing
firm. She is a late
bloomer but was fortu-
nate enough to acquire a
small two-bedroom flat
a few years ago with a mortgage of $3,950 per
month, which matures when she retires.
All things considered Martha reckons that
in light of her numbers, she more than likely
will not be in a position to purchase a second
property to supplement her retirement income.
As such, when she was 45 she started to aggres-
sively set aside 20 per cent of her gross monthly
income ($2,500) in a stock-based mutual fund.
The fund has been yielding on average about
five per cent per annum.
When she retires she plans to take this money
and deposit it into a high interest bank account
and withdraw nothing more than $1,500 per
month to augment her NIS & company pen-
sions, which will be $3,000 and $1,250 respec-
A parishioner at her church---Malcolm---
works with a top insurance company. He has
proposed that she direct the accumulated and
future funds to a no-load registered annuity
with his company which he claims has a guar-
anteed interest rate of 1.5 per cent during the
accumulation period and at retirement she will
receive a pension for life, which will work out
to be about six per cent of her capital.
Martha believes she can do well enough using
her strategy especially in light of the returns
Nick's Assessment & Advice
Martha is a microcosm of a larger part of our
society that is scarcely in a position to acquire
their first property. In fact, many people will
never own a home before their golden years.
Whilst homeownership is still optional---retire-
ment is not---and having money set aside for
this phase of life is not a choice but an imperative.
I quote a fellow adviser in the insurance and
financial services industry Roger Alcantara:
"When better cannot be done, worse must con-
In other words, one must do the best one
can, where one is in life, with what one has.
Martha has a very good attitude in that she is
facing reality head on but still doing what she
can with the knowledge and resources she has
at her disposal.
Amortisation versus perpetuity
Martha s strategy is finite in that her cash
flows will eventually come to an end when her
resources are exhausted. Annuities provide pen-
sion incomes that are perpetual in nature and
are designed to outlive the person; notwith-
standing the ravages of inflation.
Perpetuities such as pension plans, take into
account actuarial calculations that factor life
expectancies and gender specific risks together
with rates of returns and investment perform-
Statistically insurance companies know exact-
ly how many people in a given population will
live past age 70 and so on. Based on this, they
can predict---with near certainty---how much
money must be paid out on each plan to guar-
antee a cash flow for life. In fact, as morbid as
it may sound, the one who dies young will sus-
tain the one who lives beyond age 100.
High variable versus
low guaranteed returns
There are a couple sayings in the financial
services industry: "past performance is no guar-
antee of future performance" and "with higher
returns come greater risks."
Martha has enjoyed a historical annualised
(variable) fund performance of five per cent,
which is in stark contrast to the 1.5 per cent
guaranteed rate offered by the annuity. When
she crosses over into retirement, she plans to
transfer her accumulated mutual fund money
into a safer one per cent variable interest bank
account. The annuity, on the other hand, will
pay a cash flow with an implied guaranteed
return of six per cent.
So, which is more profitable: a low guaranteed
rate when accumulating, followed by a superior
locked in rate at retirement---or---a higher vari-
able rate during accumulation and a low variable
rate at retirement?
Table 2 shows estimates the present value
of her fund based on the historical rate of return
of five per cent and her savings of $2,500 per
month. It then shows what could happen if
she continues, "as is" to age 60 or if she shifts
everything over to the to annuity.
Charges & tax treatment
On the surface, Table 1 might seem to favour
the stock mutual fund more than the annuity
but don t bring out the champagne just yet!
Table 2 shows a comparative analysis of all
three instruments under consideration.
If Martha s mutual fund has a front-end-
load or charge (often called a bid/offer spread)
of say five per cent up front, only $2,250 (95
per cent of the $2,500) will actually be invest-
ed--- Table 1B factors this adjustment.
Using an adjusted present fund value of
$116,373, if Martha continues as is, with $2,250
in the stock mutual fund or $2,500 to the no-
load annuity, we can see a change in her future
values at age 60.
The other consideration is that of the impact
of taxes. Whilst the mutual fund has a favorable
historical rate of return, it does not offer any
tax benefits for retirement savings. Conversely,
the annuity will yield a 25 per cent tax deferral
or rebate on annual contributions up to max-
imum of $50,000 by law.
What this means is that with each $2,500
she should see a tax refund of $625 monthly
or $7,500 annually. Martha s gross income is
estimated at $12,500 because her annuity pay-
ment of $2,500 is 20 per cent of her gross
income ($2,500 / 20%). This means that she
will fully benefit from the annuity tax savings
as her current monthly tax bill is approximately
$1,750, which is in excess of the potential refund
of $625 monthly.
Table 1C shows the cumulative effect of her
tax savings to age 60. Our calculations assume
that these refunds are not invested but kept in
a zero interest savings account.
In the final stage of this story, Martha plans
to take the $582,621 from her stock mutual
fund and sink it into a bank savings account
which we assume will yield a safe one per cent
annually. She will then draw down $1,500 per
month which will last for just over 39 years.
If she accepts Malcolm s offer of an implied
six per cent pension with a total initial invest-
ment value of $575,480 she should receive a
monthly income of $2,877 for life.
If she chose to draw down the sum of $2,877
from her savings account balance of $582,621
she will be able to do so for 18.5 years. If Martha
lives beyond age 78 her income from her savings
account will fall off abruptly when the account
Based on today s tax-free limit on emolument
incomes of $6,000 monthly ($72,000 annually)
for people age 60 and over she will not pay
any taxes on her $2,877 pension even though
it is considered taxable income.
This analysis was designed solely to illustrate how a
qualified financial adviser might approach two different asset
classes when planning for a particular goal. The information
presented in this case must not be taken as a substitute
for professional financial advice as each product and
client/investor's situation is different and there may be other
variables to consider when coming up with a final investment
decision. (Cases are developed from a combination of scenarios
received from our readers)
If you have any questions or need advice on
today's subject please e-mail me at:
email@example.com or web at: www.Finan-
APRIL 26 • 2015 www.guardian.co.tt SUNDAY BUSINESS GUARDIAN
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