Home' Trinidad and Tobago Guardian : March 16th 2017 Contents MARCH 16 • 2017 guardian.co.tt BUSINESS GUARDIAN
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Option 3's zero-year guarantee speaks to
what happens if Wayne should die in retire-
ment. With this option, even if he dies the day
after his first pension payment, the cash flow
would immediately stop and all of the money in
his pension fund would stay with the company.
Pension providers therefore offer guaranteed
periods of up to 15 years after the first payment.
This means that should the annuitant die with-
in that time frame an appointed beneficiary
would continue receiving monthly payments
until the guaranteed period has expired.
Selecting a 15-year "term-certain" comes at
a cost. In Wayne's case it would mean sacrific-
ing $184 ($4,719 - $4,535 = $184) of monthly
income in exchange for the guarantee. The
question is: should Wayne take the maxi-
mum guarantee, as he simply does not know
Now, if he selected the 15-year guarantee, the
pension provider is committing to paying out
the lesser of the monthly amount for the rest of
his life or 15 years the latter, which works out
to be $816,300 ($4,535 x 12 months x 15 years).
You would notice that this total is not too
much different from the current fund value of
$849,000, which means he is guaranteed to get
back almost all of his original funds. Whilst this
looks pretty reasonable, it does not account
for the time value of money at least from two
1. With inflation the value of $816,313 spread
over 15 years would not be worth the same as it
is today. Every successive monthly payment
would be worth less and less.
2. If he had that or some other lump sum of
money up front, Wayne may be able to invest it
to generate a monthly income and get a return
on investment of the capital that is equal to or
greater than the rate of inflation. By doing so
Wayne would not only have an income source
but the ability to pass on a valuable asset to his
family after he dies, compared with a forfeiture
of his capital and cash flows after only 15 years
or later death.
Control of capital
If Wayne chooses to assume control of all or
part of his capital he can select Options 1 or 2.
With Option 1 he assumes full control minus
25% tax; with Option 2 Wayne can get more
than half of his cash tax free but will is still
subjected to the forfeiture of his remaining
capital and cash flow upon death.
Now if he has no problem with not leaving a
chunk of his wealth for his family, he can select
either Option 2 or 3. But if Wayne wants to
try and get the best of both worlds, he could
consider Option 1, but this means he has to
accomplish the following objectives:
1. Recovery of the heavy tax loss of $212,250.
2. Get income that outstrips the income of
at least Option 2 and better Option 3
3. Get income that keeps pace with inflation
4. Preserve and grow his inheritance for his
Wayne needs to evaluate if pursuing this
route could achieve the objectives above.
Tax Consideration: First of all Option
1 assumes that the tax charge of $212,250 is
an outright loss. The truth is he would have
received a tax refund of up to 25 per cent for
every dollar invested in a registered annuity.
Which effectively means only 75 per cent of
his money went into the annuity before re-
tirement. So in way the government's taxes
had the opportunity to be invested and earn
interest over the years.
Therefore, it is not unreasonable for the gov-
ernment to recapture its rightful tax should
he cash out.
Income Consideration: If Wayne takes
Option 1 he would have $636,750 in hand
which he will use to build the annex, which
when finished will generate rent of $3,500 per
month, which is $1,235 ($3,500- $2,265) more
than the Option 2 maximum reduced pension
with the zero guarantee period.
This difference would be smaller if Wayne
invested the tax-free lump sum of $441,480
in some other income-generating asset that
hopefully could match or surpass the inter-
est rate of the pension as the zero guarantee
period option ($2,265 x 12 months / $407,520
As regards to the pension income of Op-
tion 3 (with zero guarantee period), the rent
would fall short of this figure by $1,219 ($3,500
- $4,719) but this would be temporary as it is a
well known fact that over time, rental income
moves in tandem with inflation and this ad-
dresses the third objective above.
How long will it take for this shortfall be-
tween the Rent Option and Option 3 (zero
guarantee period) to be eliminated?
It would depend on the rate at which Wayne
increases the rent over time or at the prevailing
rate of inflation. With general price increas-
es the value of Wayne's property would also
increase so the fourth objective to grow the
property inheritance will also be achieved.
Whilst any increase in the property value is
not realised (collected in hand), as is the case
of rental income, it must also be included in
calculating the overall benefit from investing
in the annex.
From our modeling we have assumed that
property prices and rents increase at three per
cent per annum.
Based on this we observed the following:
1.In the second year, the combined earn-
ings from the annex (that is the annual
property increase plus the total annual rental
income) would exceed the maximum pension
in Option 3 by $5,735.
2.In the 11th year the value of the annex
would be $855,739, which is an increase
of $218,989 from the original investment of
$636,750. At this point the original tax loss
of $212,250 would have been fully recovered.
3.In the 12th year the annual rental income
would have exceeded the maximum
annual pension in option 3 by $1,510 ($58,138
- ($4,719 x 12 = $56,628)).
4.In the 15th year the gains received from
the annex (rent & capital appreciation)
would be $1,107,546 whilst the total value
received from Option 3 (zero year guarantee)
would be $849,420 a difference of $258,126
and rising with each passing year.
Nicholas Dean (CertFa) is a certified independent
financial adviser and is the managing director of
The Financial Coaching Centre Ltd. If you have any
questions or need advice on today's subject please
email: firstname.lastname@example.org or visit website: www.
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