What is an Annuity and How to Evaluate Retirement Annuity Plan?
The plan is also pretty “inflexible” as you are not allowed “redeem” your paid premium for the first 15 years in case of any financial emergency.
It is likely that most people will adopt a simplistic approach to calculate the return of this retirement annuity plan, assuming current age is 30 years.
Disregarding the time value of money, for a total invested amount of RM (500 x 12 x 15) = RM 90,000, you get back RM (4,000 x 30 + 73,000) = RM 193,000. Your response: 90k over 193k is a 46.6% return!
Here’s the correct way to calculate your return for this type of deferred retirement annuity, using Internal Rate of Return (IRR) in Microsoft Excel. I will guide you through step by step.
It should look something like the table on the left.
In any empty cell, type this formula: “=IRR(B2:B46,0.03)”
Select this cell, right click > “Format Cells…” > “Number” tab > “Percentage”
Change decimal places to “2”
You should get IRR = 2.89%
This means, the annualized effective compounded interest rate of return of this plan over the 45 years period is 2.89%.
Another way to put it:
The return per annum of your total cash inflows over your total cash outflows is 2.89 percent.
Ponder over this alternative:
The monetary return will be more than the aforementioned retirement annuity plan if today, a risk averse person locks RM 90,000 into a FD account with a constant interest rate of 3% for the next 45 years.
Do you think that retirement annuity plans are for those who are not sufficiently disciplined to manage their own expenses and investment?
If you have similar plan being offered to you by your insurance agent or banks, do let me know the details by leaving a comment below or at my Facebook page. We can analyze your case for the benefit of the masses.