【QDAP Savings】A tax-saving marvel emerges? Breaking down the payback period of tax-deductible annuities. How can you achieve higher returns? (Using a 35-year-old policyholder as an example)

Qualifying Deferred Annuities (QDAPs) were once described as a “tax-avoidance wonder”, because some QDAP products previously had a break-even period as short as five years. Policyholders could surrender their policies after completing five years of premium payments and still break even, treating the tax deductions received during the premium payment period as “returns”. The resulting internal rate of return (IRR) even surpassed that of other QDAP products. This seemingly gave policyholders an incentive to surrender their policies early, contrary to the purpose of making medium- to long-term savings for retirement. Therefore, since last year, the guaranteed break-even period for QDAPs has been extended to at least eight years. Based on a 45-year-old policyholder surrendering the policy at the guaranteed break-even year, the maximum tax-adjusted return is only 3.04% IRR (Note 1). If the policyholder holds the policy for the long term, the IRR (including tax deductions) will be higher, substantially reducing the incentive to surrender early. Just when everyone thought there were no more “tax-avoidance wonders” in the market, 10Life discovered what may be a missed opportunity…

Under the regulations, QDAP product brochures must state the IRR for a 45-year-old policyholder. However, taking out a policy at different ages, with different premium payment periods and income periods, will produce different IRRs. Therefore, 10Life’s QDAP (Savings) category in its Product Decoder now includes options for policyholders aged 35, allowing relatively young high-income earners to consider using QDAPs as medium-term retirement savings. This article analyses QDAPs for a 35-year-old policyholder who pays premiums for five years, with total premiums of US$39,000, begins receiving income at the earliest time available (age 50 or the nearest age), and compares the internal rates of return for the shortest income period of 10 years (that is, until age 60). 

Chart 1: Comparing the internal rates of return of QDAPs for savings purposes (policyholder: male aged 35)

Assuming that the policyholder is a 35-year-old male, with a five-year premium payment period, total premiums of US$39,000, an income period starting at age 50 (or the nearest age), a minimum income period of 10 years or more, and the currency being US dollars²

Are there still QDAPs whose return from surrendering at the guaranteed break-even year is higher than the return at maturity?

Many readers are concerned about the guaranteed break-even year of QDAPs. Chart 1 shows that the guaranteed break-even year can be as short as eight years for Hang Seng’s “eIncomePro” (hereinafter referred to as Hang Seng QDAP), Bank of East Asia’s “Save” Future Preferred (hereinafter referred to as BEA QDAP), and FTLife’s “Prosperous” (hereinafter referred to as FTLife QDAP).

• First, for BEA QDAP and FTLife QDAP, although surrendering at the guaranteed break-even year of eight years can produce a guaranteed IRR of 3.1% (including tax deductions) (Note 1), policyholders may still obtain higher guaranteed or projected returns by continuing to hold the policies.
• BEA QDAP is a fully guaranteed product. Including tax deductions, both its guaranteed and projected IRRs at age 60 can reach 2.92% (Note 1). Although this is not particularly apparent from Chart 1, if the policy is held until maturity at age 70, the IRR can reach 4.1% (Note 1).
• Including tax deductions, the guaranteed IRR of FTLife QDAP at age 60 is only as high as 1.7%, while its projected IRR, including non-guaranteed components, can reach 4.7% (Note 1). This product focuses on non-guaranteed returns in the later policy years. If the policy is held until maturity, its projected IRR may increase further. In addition, FTLife QDAP has a total term of up to 40 years (from age 35 at policy inception until the end of the annuity period at age 74), which is relatively long. Under Guideline 19, the minimum guaranteed component requirement may therefore be relaxed from the most stringent 70% to 50% (Note 2). As this product has a higher non-guaranteed component, policyholders must assume higher risk in exchange for potentially higher long-term returns.
• Hang Seng QDAP is also a fully guaranteed product. Its guaranteed and projected IRRs are the same. Its guaranteed IRR is 1.81% before tax deductions and rises only to 2.85% after tax deductions, but this is still lower than the 3.04% IRR (Note 1) obtainable by surrendering at the guaranteed break-even year (eight years) and benefiting solely from the tax deductions. In other words, continuing to hold this product after the guaranteed break-even year will not improve its guaranteed or projected return.

Tax avoidance offers a short-term benefit; compounding supports long-term savings

In the above example, if the policyholder focuses on tax avoidance and intends to surrender the policy at the guaranteed break-even year, the only benefit obtained is the tax saving. At a tax rate of 17%, a product with five years of premium payments can save a maximum total of US$6,630 in tax. This can also be regarded as a premium reduction, reducing the original total premiums of US$39,000 to US$32,370, as shown in Chart 2. However, if the policyholder does not actively seek other investments after surrendering the policy, the funds will not benefit from compounding, and their value will gradually be eroded by inflation. Therefore, do not assume that not investing means there is no risk. 

Chart 2: Comparing the cash value including income of QDAPs for savings purposes (policyholder: male aged 35)

Assuming that the policyholder is a 35-year-old male, with a five-year premium payment period, total premiums of US$39,000, an income period starting at age 50 (or the nearest age), a minimum income period of 10 years or more, and the currency being US dollars²

Conversely, if the policyholder continues to hold the annuity and allows the funds to accumulate within the policy, then, continuing the above example, the policyholder will have accumulated considerably more cash value including income by age 60 than the amount paid in premiums, as shown in Chart 2:

• The guaranteed amount for BEA QDAP is US$56,133.
• The guaranteed amount for Hang Seng QDAP is US$53,753.
• The guaranteed amount for FTLife QDAP is US$46,927, while the projected amount is as high as US$58,309 (including non-guaranteed components).

In the past, tax-avoidance wonders could generate an IRR of up to 5.9% (including tax deductions) when surrendered at the guaranteed break-even year. However, those seeking tax savings through QDAPs today will find that the IRR from surrendering at the guaranteed break-even year is considerably lower than before. At the time of writing, short-term savings insurance products in the market can also provide policyholders with an IRR of more than 3%.

Do not focus solely on breaking even; understand the returns of QDAPs

Setting aside the guaranteed break-even year and looking again at QDAP returns, Chart 1 shows that Sun Life QDAP has the highest guaranteed product IRR at age 60, at 2.23% (before tax benefits). After taking tax deductions into account, the guaranteed IRR may increase to 3.27% (Note 1). As for projected returns including non-guaranteed components, YF Life QDAP has the highest return, with a product IRR of 4.04%. After taking the tax effect into account, the projected IRR may rise to 4.9% (Note 1).

Finally, 10Life would like to remind everyone that before taking out a QDAP, you should first understand the purpose of the investment and your affordability, as well as the potential risks of QDAPs, such as losses from early surrender, liquidity risk, and changes in your personal financial and employment circumstances. If you would like to learn more about other QDAP products, please visit the 10Life website for more detailed product comparisons:

• QDAP (Savings): focuses on medium-term savings returns (annuity income begins before the usual retirement age)
• QDAP (Retirement): focuses on medium- to long-term retirement planning after retirement (annuity income begins at the usual retirement age, with a selectable income period of 10 or 20 years)
• QDAP (Longevity): focuses on hedging longevity risk (annuity income begins at the usual retirement age, with a longer payment period and, in some cases, payments for life)

Notes:

1. Assuming that the policyholder pays HK$60,000 per year for five years and pays tax at the highest rate of 17%.
2. Insurance Authority Guideline 19 on the “minimum percentage of guaranteed annuity payments to the total amount of projected annuity payments”.

The above information is provided by 10Life and updated as at 16 March 2021. It is for reference only and 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.