Deferred Tax Annuities

Making enough money in forty years to support ourselves for another forty is a tall order

As we discussed over the last three weeks, you need to take some time to plan for your retirement.?

Laura Carstensen in her book, “A Long Bright Future”, notes:

“Those of us living today have been handed a remarkable gift with no strings attached: an extra thirty years of life for the average person. … Old age itself is a new phenomenon. … For most of human history, life expectancy was just shy of twenty years—barely long enough to ensure the survival of the species. Over time, that? norm slowly crept upward, hitting the mid-thirties in the nineteenth century. Then—in a blink of an eye, in evolutionary terms—the average lifetime increased dramatically. By the end of the twentieth century, life expectancy was seventy-seven years. Today it is seventy-eight.

“What’s wild is that seventy-eight is just an average. … Nervous folks who direct pension plans are considering the possibility that a far larger number will reach one hundred. One prominent demographer has suggested that most of the children born in the developed world since 2000 will live for a century.”

She advises that:

“Making enough money in forty years to support ourselves for another forty is a tall order, no matter what state Social Security may be in by the time you reach retirement age. … If you expect to live as well after retirement as before, you’re going to have to save a lot of money without relying on the government or your employer to do it for you.”

After calculating how much you will need, based on the advice in last week’s column, you may have realized that your company provided pension and Trinbago’s social security programs, i.e., national insurance or senior citizens pension, may not be enough to live like you want at retirement.

DEFERRED TAX ANNUITIES

Deferred-tax annuities or individual retirement plans, approved under various sections of the Income Tax Act of Trinidad & Tobago, are long-term savings accounts that allow individuals to take retirement planning into their own hands.? They offer considerable advantages as an investment vehicle for retirement planning, the most significant of which is its power to maximize returns on your investment through compound interest.

Deferred-tax annuities are long-term savings accounts that can supplement national insurance and employer provided pension plans.?

Although designed primarily for self-employed people like entrepreneurs, sole proprietors and professionals, including lawyers, accountants and doctors in private practice, who do not have access to company provided pensions, these deferred-tax annuities can also serve to supplement national insurance and employer provided pension plans.?

By making flexible, discretionary contributions to an approved tax deferred annuity, you can be guaranteed lifetime income during your later years.? The concept behind approved deferred annuities is simple:? you pay a premium, usually monthly, which accrues interest to the age you would like to retire, with the added advantage of growing tax-free until retirement. ?You may choose for the plan to mature between the minimum age of 50 and maximum age of 70.

Key features of approved deferred-tax annuities in Trinbago are:

• Your total contributions to approved pension funds, approved deferred annuity plans, and 70% of National Insurance are tax deductible up to a maximum sum of TT$60,000 per year effective from January 1, 2022. ?To qualify for deductions, the pension funds and annuities must be approved by the Board of Inland Revenue (BIR);
• If you wish to terminate your annuity contracts prior to maturity, you must get the BIR’s approval. ?Since tax breaks would have been granted on the amounts contributed, if the contract is broken before maturity/retirement, any amounts received would be taxed at the rate of 25%;
• You are allowed a tax-free lump sum at maturity, which equates to 25% of all contributions made plus 100% of the interest earned on your contributions during the term of the plan. ?The remaining 75% of your contributions may be subject to tax.

TATIL Life’s Living Reward Series, Republic Bank’s Tax Incentive Savings Plan (TISP) and Sagicor’s Tax Secure Annuity Plan (TSAP) are examples of approved tax-deferred annuities that offer these features and benefits.

Deferred-tax annuity contracts are usually structured into two phases namely the accumulation phase and the pay-out phase.

ACCUMULATION PHASE

During the accumulation phase, interest accumulates on your premiums tax-free until the maturity of the contract. ?The method in which interest accumulates depends on whether a fixed, indexed or variable rate of interest is chosen.

• Fixed annuities promise a specific, guaranteed rate of return, regardless of market conditions.
• Indexed annuities provide a return based on the performance of a particular market index, e.g., The Trinidad and Tobago Stock Exchange’s (TTSE’s) Composite Index, All T&T Index, Cross-Listed Index and international indices like the Dow Jones Industrial Average (DJIA), S&P 500, the FTSE 100 or the Nikkei 225.
• Variable annuities are based on the performance of a portfolio or mutual funds chosen by the annuity holder.

As the purpose of the deferred-tax annuity is to encourage long-term investment, individuals are discouraged from making withdrawals during the accumulation phase. Accordingly, withdrawals during this period, as noted above, may be subjected to surrender charges and will be taxed.

PAY-OUT PHASE

At maturity, the pay-out phase begins and you’ll begin receiving a regular monthly income, based on the accumulated value of the plan.

THE POWER OF TAX DEFERRED COMPOUNDING

Compounding occurs when interest is paid on previously earned interest. So, if you have a fixed deposit which pays an interest rate of 3.0%, all future interest will be compounded on the total of principal and accumulated interest.? You should note that investments where income is taxed at a 25% tax rate, will only earn 2.25% after tax.

Whatever your level of investment knowledge, deferred-tax annuities can help to provide financial security in retirement.

However, an approved deferred annuity, allows your money to grow and compound faster than money in a taxable account. ?At 3.0%, compounded annually, contributions of $1,000 a month can grow to $139,741 in 10 years. ?At 2.25%, you’d only have $134,431.? See the table below for the results for 20 and 30 years.

The higher your tax bracket and the longer you defer, the bigger the advantage, remember the time value of money.? As the table below shows if you can consistently earn 5%, the amount available to purchase an annuity after 30 years grows to $832,259, just under $170,000 more that the taxed equivalent.

The bottom line is that deferred-tax annuities are more beneficial than other investments because they allow you to capitalise on the tax deductible benefit and make it painful to withdraw the funds before maturity.? They offer a convenient tax efficient way of saving for retirement.

As shown above, compared to other non-tax deferred investment options with similar return profiles, these products are able to make higher dollar value returns with equivalent contributions and should be explored by all types of investors. Whatever your level of investment knowledge, deferred-tax annuities can help to provide you the financial security needed to retire as you please.

Have a disciplined week as you work to build your financial freedom.? If you find this advice helpful, please share with your friends and colleagues. ?As usual, I look forward to your questions and comments.? Be safe.? Take good care, and if you can, help someone in need.

Cheers, Nigel

Nigel Romano, Partner, Moore Trinidad & Tobago, Chartered Accountants

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