Annuity Products or Voluntary Pension Contributions — which one is better for Retirement Finance Planning?

There are two tax-deductible investments if you are looking to invest for retirement — annuity products and voluntary pension contribution. Although both are tax-deductible (which means you can reduce the taxable amount of the year by the amount of investment you made to these schemes — note that there should be a maximum cap).

Many (including myself) have confusion about how these two types of investment work and what are the differences, therefore I would like to share what I found after a week’s research in the hope to provide more clarity if you are considering putting money into one of these schemes.

Background

The pension system has changed. Previously, employers are fully responsible to contributing to employees’ pension. Nowadays, employees are mainly responsible to contributing to our own pension.

Some jurisdiction also specifies in-laws and regulations the mandatory amount that you have to contribute to the pension each month (say 5%), and your employer would contribute the same amount to your pension.

The contributed amount would definitely not be sufficient for retirement. That is only there to make sure that every employee would at least have ‘some’ savings for retirement.

While the life expectancy lengthens, medical costs skyrockets, and the ratio of the elderly population grows notably, the governments want people to save more for retirement so that the government’s burden could be lessened.

That’s how the annuity products and voluntary pension contribution comes into the picture.

Annuity Products

(two types)

Voluntary Pension Contribution

Employees can open a voluntary contribution pension account with any pension providers to invest in the fund of his or her own choosing. The investment (same as the mandatory pension) can only be withdrawn upon scheme member’s reaching age 65 (or on other statutory grounds).

Different funds would cover diverse assets e.g. stocks of various jurisdictions, large-cap, mid-cap, small-cap, government bonds, corporate bonds, index-tracking etc.

The difference

The difference between annuity products and voluntary pension contribution scheme:

Nature

An annuity product is more of an insurance product rather than an investment product. It helps to deal with longevity risk (i.e. we outliving our pension) and inflation.

A voluntary pension contribution scheme is more of an investment scheme. Similar to the mandatory pension scheme, the money you put into the account will be invested in funds.

Capital protection

The capital invested in annuity products is protected 100%. Therefore, it is a relatively lower risk than the voluntary pension scheme in this aspect.

The voluntary pension scheme doesn’t protect your capital. In fact, as it invests your money in funds, there could be a chance that when you retire, your money does not grow at all or even have losses.

Hence, generally, if you are closer to retirement and prefer less risk with your capital, annuity products should be a better choice. On the other hand, if you are in your 20s — 40s and you can afford to take more risk with the capital, the voluntary pension scheme is more suitable for you.

Providers

Providers for annuity products are insurance companies while providers of voluntary pension schemes are pension trustees and banks.

Time value

Annuity products, because of its capital preservation nature, would not have much growth compared to the return potential of the funds. Of course, it will not share the potential loss as well.

Voluntary pension scheme, on the contrary, could have better potential of growth in the long run and would be more suitable if you are in your 20s to 40s and have 10–20 years or more to go before you retire.

Fees

You don’t have to pay management fees or the like for annuity products, but there is fees for the funds in the voluntary pension scheme. The average fee ratio is 1.4% which, to me, is quite high and would definitely have an impact on the actual return (especially if the fund that you choose produces only 3–4% a year). And over a period of years, the fees could accumulate to an unexpected level (which could be millions of dollars we are talking about here). As such, I would as much as possible go for funds that are lower in fees (say 0.8 or less than 1%).

Similarity

The similarity between annuity products and voluntary pension contribution scheme:

Exit

The distribution of both the annuity products and voluntary pension contributions starts at 55 or 60 or 65 (i.e. at retirement age). The money cannot be withdrawn until then (unless on other statutory grounds).

Tax advantage

Both the annuity products and voluntary pension contributions are eligible for tax deduction in the year of payment. For example, in 2019/2020, you invested $5000 into voluntary pension account or paid $5000 as a premium for the annuity plan, then the taxable amount of 2019/2020 should be reduced by $5000. If your tax rate is 35%, that could mean $1750 saving in tax. (Please consult a professional tax advisor if needed)

All in all, the annuity product and voluntary pension scheme offer great tax deduction and we should consider taking this opportunity to use one of these tools for better retirement financial planning. As to which one is more suitable for you, it depends on your age, risk appetite etc., but hopefully, this sharing of my own research can offer you more insight in choosing the right one for yourself.

Note: this is not investment advice. I’m not financial planning professional. Just sharing what is working for me as part of my investing strategy or what I have learned on my investment journey. Please be reminded to do your own research and consider your own circumstances before making any financial decisions. You could also check with your financial professional to understand what would be best for your situation.