【QDAP Savings】A Tax Avoidance Tool? Analysing the Break-Even Year of Deductible Annuities. How to Achieve Higher Returns? (Example Based on a 35-Year-Old Policyholder)

Tax-deductible annuity QDAP was once dubbed a "tax avoidance tool" because some QDAP products in the past had a breakeven period as short as 5 years. Policyholders could surrender their policies after completing contributions over 5 years and still recover their investment, treating the tax deductions received during the contribution period as a form of "return". The internal rate of return (IRR) achieved was remarkably the highest among QDAP products. This seemed to incentivise early policy surrender, which contradicted the purpose of medium-to-long-term savings for retirement. Consequently, since last year, the guaranteed breakeven period for QDAP has been extended to a minimum of 8 years. If a 45-year-old policyholder surrenders at the guaranteed breakeven year, the highest tax deduction return achievable is only 3.04% IRR (Note 1). However, if the policyholder holds the policy long-term, the IRR (including tax deductions) would be higher, significantly reducing the incentive for early surrender. Just when everyone thought the market no longer had a "tax avoidance tool", 10Life discovered what appears to be a potential loophole in the market...

According to regulations, QDAP product brochures must list the IRR for a 45-year-old policyholder. However, the IRR varies depending on the age at which one purchases the policy, as well as the chosen contribution and income periods. Therefore, 10Life's 《Product Decoder》 under the QDAP (Savings) category has added an option for 35-year-old policyholders, allowing relatively younger high-income individuals to consider QDAP as a medium-term retirement savings tool. In this article, we will analyse a 35-year-old QDAP policyholder who contributes for 5 years with a total contribution of USD 39,000, starts receiving income at the earliest possible age (50 or the closest age), and compare the internal rate of return over the shortest 10-year income period (i.e., up to age 60). 

Chart 1: Comparison of Internal Rate of Return (IRR) for QDAP with Savings Purpose (Policyholder is a 35-Year-Old Male)

Assumption: The policyholder is a 35-year-old male, with a 5-year contribution period, total contribution of USD 39,000, income period starting at age 50 (or closest age), shortest income period of 10 years or more, currency in USD²

Is the Return Rate of QDAP Surrender at Guaranteed Breakeven Year Higher Than Holding Until Maturity?

Many readers are concerned about the guaranteed breakeven year of QDAP. Chart 1 shows that Hang Seng 「Easy Income」 (hereinafter referred to as Hang Seng QDAP), Well Link 「Save」for Future Superior (hereinafter referred to as Well Link QDAP), and FTLife 「Prosperity」 (hereinafter referred to as FTLife QDAP) have guaranteed breakeven periods as short as 8 years.

• First, for Well Link QDAP and FTLife QDAP, although surrendering at the 8-year guaranteed breakeven point can yield a guaranteed IRR of 3.1% (including tax deduction) (Note 1), policyholders who choose to retain the policy may still achieve higher guaranteed or projected returns.
• Well Link QDAP is a fully guaranteed product. Including tax deductions, both the guaranteed and projected IRR at age 60 can reach 2.92% (Note 1). Although Chart 1 does not show this prominently, if the policy is held until maturity at age 70, the IRR can reach 4.1% (Note 1).
• Including tax deductions, FTLife QDAP’s guaranteed IRR at age 60 is only 1.7%, while the projected IRR (including non-guaranteed components) can reach 4.7% (Note 1). This product focuses on non-guaranteed returns in the later stages of the policy. If held until maturity, the projected IRR is expected to increase further. Additionally, FTLife QDAP has a total duration of 40 years (from age 35 to the end of the annuity period at age 74), which is relatively long. According to Guideline 19, the requirement for the minimum guaranteed portion can be relaxed from the strictest 70% to 50% (Note 2). Due to the higher non-guaranteed component, this product carries greater risk in exchange for potentially higher long-term projected returns.
• Hang Seng QDAP is also a fully guaranteed product. The guaranteed IRR and projected IRR are the same, with a guaranteed IRR of 1.81% (excluding tax deduction), rising to only 2.85% after tax deduction. However, this is still lower than the 3.04% IRR (Note 1) achievable purely from tax savings by surrendering at the guaranteed breakeven year (8 years). In other words, for policyholders of this product, retaining the policy beyond the guaranteed breakeven year does not increase the guaranteed or projected return rate.

Tax Avoidance for Small Gains: Compounding Effect Supports Long-Term Savings

In the above example, if a policyholder focuses on tax avoidance and plans to surrender at the guaranteed breakeven year, the only benefit gained is tax savings. At a 17% tax rate, for a 5-year contribution product, the total tax saved is up to USD 6,630. This can be viewed as a premium discount, reducing the total contribution from USD 39,000 to USD 32,370, as shown in Chart 2. However, if the policyholder surrenders and does not actively seek other investment opportunities, the funds will not generate compound interest, and their value will gradually be eroded by inflation. Therefore, do not assume that not investing carries no risk. 

Chart 2: Comparison of Cash Value Plus Income for QDAP with Savings Purpose (Policyholder is a 35-Year-Old Male)

Assumption: The policyholder is a 35-year-old male, with a 5-year contribution period, total contribution of USD 39,000, income period starting at age 50 (or closest age), shortest income period of 10 years or more, currency in USD²

Conversely, if the policyholder continues to hold the annuity, allowing the funds to compound within the policy, following the above example in Chart 2, by age 60, the policyholder would have accumulated (far more than the contribution amount) cash value plus income:

• Well Link QDAP’s guaranteed amount reaches USD 56,133
• Hang Seng QDAP’s guaranteed amount reaches USD 53,753
• FTLife QDAP’s guaranteed amount is USD 46,927, with a projected amount of USD 58,309 (including non-guaranteed components).

In the past, the "tax avoidance tool" could achieve an IRR of up to 5.9% (including tax deduction) by surrendering at the guaranteed breakeven year. However, currently, for those seeking to avoid tax through QDAP, the IRR for surrendering at the guaranteed breakeven year is significantly lower. As of the publication date, there are also short-term savings insurance products in the market offering policyholders an IRR exceeding 3%.

Don’t Focus Solely on Breakeven: Understand QDAP’s Return Rates

If we set aside the breakeven year consideration and focus on QDAP’s returns, Chart 1 shows that Sun Life QDAP has the highest guaranteed IRR at age 60, reaching 2.23% (excluding tax benefits). When factoring in tax deductions, the guaranteed IRR could rise to 3.27% (Note 1). As for projected returns including non-guaranteed components, the highest is YF Life QDAP, with a projected IRR of 4.04% for the product itself, potentially increasing to 4.9% after factoring in tax deduction effects (Note 1).

Lastly, 10Life would like to remind everyone that before purchasing a QDAP, it is essential to understand the purpose of the policy and your affordability, as well as the potential risks of QDAP, such as losses from early surrender, liquidity risks, and changes in personal financial or employment circumstances. If you wish to learn more about other QDAP products, you can visit the 10Life website for a more detailed product comparison:

• QDAP (Savings): Focuses on medium-term savings returns (annuity income starts earlier than the typical retirement age)
• QDAP (Retirement): Emphasises medium-to-long-term retirement planning after retirement (annuity income starts at the typical retirement age, with options for 10-year or 20-year income periods)
• QDAP (Longevity): Focuses on hedging longevity risk (annuity income starts at the typical retirement age, with longer payout periods, some even lifelong)

Notes:

1. Assumption: The policyholder contributes HKD 60,000 annually for 5 years and is subject to the highest tax rate of 17%.
2. Insurance Authority’s 《Guideline 19》 regarding "the minimum percentage of guaranteed annuity payments to total projected annuity payments".

The above information is provided by 10Life, updated as of 16 March 2021, and is for reference only. It does not constitute sales advice. 

This English version of this article has been generated by machine translation powered by AI. It is provided solely for reference purposes. In the event of any discrepancy or inconsistency between this translation and the original Chinese version, the Chinese version shall prevail.