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A new tax-saving tool for 2020? With tax deductions, can a deferred annuity break even in as little as one year?!
The Government introduced Qualifying Deferred Annuity Policies (QDAPs) to encourage everyone to start saving early and prepare for retirement. Last year, the media reported that the guaranteed breakeven year of the BOC Life Deferred Annuity Plan (Fixed Term) could be as early as five years. Policyholders could surrender their policies immediately after completing their premium payments and, if they fully utilised the 17% tax deduction, could achieve a guaranteed internal rate of return (IRR) of up to 5.9% over five years. It was regarded as a “tax avoidance wonder product” (see Note 1). Subsequently, the Insurance Authority intervened, emphasising that QDAPs should be used for long-term savings and that excessive focus should not be placed on tax deductions. The breakeven year of the BOC Life QDAP was consequently extended to eight years (see Notes 2 and 3). 10Life reviewed several QDAPs on the market with five-year premium payment periods, and found that their shortest guaranteed breakeven period was also eight years.
Unconventional “prepayment” design of the QDAP allows breakeven in one year including tax rebates
Although QDAPs that break even immediately after five years of premium payments have disappeared, we found that Generali’s Tax Saver Deferred Annuity offers a prepayment option (hereinafter referred to as Generali QDAP (Prepayment)), which can shorten the policy’s guaranteed breakeven period. In practice, the policyholder must first establish a “premium prepayment account” with the insurer and deposit the total premiums for five years, amounting to US$36,482, into the account in one lump sum. The balance in the account also earns interest, which is used to pay the premiums. The insurer then withdraws US$7,800 from this account each year (equivalent to approximately HK$60,000, the maximum premium eligible for tax deduction) to pay the premiums, allowing the policyholder to enjoy the tax benefits each year. If the policyholder completes five years of premium payments through the “premium prepayment account”, the product’s guaranteed breakeven period is only seven years (before taking tax deduction returns into account), which is faster than other QDAPs on the market, which take at least eight years to break even.
More interestingly, after taking tax deductions into account, the breakeven period of Generali QDAP (Prepayment) may be shortened further. Based on the example above, the policyholder is a high-income individual subject to a 17% tax rate. If they surrender the policy one year after taking it out, although the product’s guaranteed cash value is only US$5,850, the policyholder can withdraw the entire balance of the “premium prepayment account” together with the interest. When the tax deduction return is added, the policyholder’s guaranteed proceeds rise to US$36,857, exceeding the prepayment amount. In other words, Generali QDAP (Prepayment) breaks even in just one year including the tax rebate, with a guaranteed IRR of 1.0%.
Surrendering Generali’s Tax Saver Deferred Annuity (Prepayment) after one year
| Policy commencement | Age 45 |
| Prepaid premiums (entire term) | $36,482 |
| Total surrender amount at age 46 | |
| (i) Guaranteed cash value | $5,850 |
| (ii) Balance of prepaid premiums (including interest) | $29,681 |
| (iii) Tax deduction return (17% tax rate) | $1,326 |
| (i) + (ii) + (iii) | $36,857 |
| 1-year guaranteed internal rate of return IRR | 1.0% |
The policy currency in the above table is US dollars.
Old and new QDAPs compared: the new product also encourages saving through tax deductions
Generali QDAP (Prepayment) allows policyholders to achieve an accelerated breakeven through tax deduction returns. We still remember that last year’s BOC Life QDAP became the industry’s “tax avoidance wonder product” because of its fast breakeven and high returns. Compared with it, can Generali QDAP (Prepayment) become a new type of tax avoidance wonder product? 10Life attempted to compare the old and new generations of QDAPs. The guaranteed internal rates of return over the entire policy terms after the 17% tax deduction are shown in the chart below. The assumption is that the policyholder is a 45-year-old high-income individual subject to a 17% tax rate.
The previous-generation BOC Life Deferred Annuity (Fixed Term) (discontinued in September 2019) allowed policyholders to surrender immediately after completing five years of premium payments. Including the 17% tax deduction, policyholders would immediately earn a guaranteed five-year IRR of 5.9%, higher than the guaranteed IRR of 5.6% if they continued to hold the policy until maturity after 15 years. The product therefore incentivised policyholders to surrender immediately after completing their premium payments, effectively reducing their willingness to save over the medium to long term.
For Generali’s Tax Saver Deferred Annuity (Prepayment into the premium prepayment account), in terms of returns, the guaranteed IRR is only 1.0% if the policyholder surrenders after one year (including the 17% tax deduction), but rises to 3.2% if the policyholder surrenders after three years. As the policyholder continues to hold the policy, the guaranteed IRR continues to increase, reaching 4.9% at maturity. This shows that the returns from early surrender of Generali QDAP (Prepayment) are lower than those of the previous-generation BOC Life QDAP. However, for a policyholder subject to a 17% tax rate, Generali QDAP (Prepayment) carries a lower liquidity risk, and early surrender (after one year) does not result in a loss. Of course, QDAPs should be taken out for savings purposes. Policyholders can continue to hold the policy to earn a higher IRR, which offers certain advantages in today’s volatile, low-interest-rate investment environment.
Generali QDAP (Prepayment) requires the policyholder to deposit the premiums for the entire term into the “premium prepayment account” in one lump sum, creating a relatively high short-term funding requirement. If the policyholder does not prepay but instead pays annually over five years, the guaranteed IRR after surrendering after five years, including the 17% tax deduction, is 2.9%, lower than that of the prepayment version. However, if the policyholder continues to hold the policy until maturity, the 15-year guaranteed IRR rises to 5.3%, outperforming the prepayment version. This return is also considered attractive in today’s QDAP market. After all, returns vary considerably among QDAPs; see the earlier article, “Tax Deduction Returns from Qualifying Deferred Annuity Policies QDAP (March 2020)”.
Overall, although Generali QDAP (Prepayment) breaks even in as little as one year including the tax rebate, the product’s ingenuity does not in fact lie in tax avoidance. Rather, it reduces liquidity risk while also allowing the IRR from medium-term savings to grow.
Finally, as we have explained in many articles, deferred annuities serve different purposes. The arguments in this article are based on medium-term returns after tax deductions. There are also many QDAP products on the market designed for retirement. When making a choice, everyone should understand their investment objective and the required income period, and select and compare products carefully.
[Comparing Qualifying Deferred Annuity Policies with the aim of maximising tax deductions and savings returns]
Notes:
10Life Blog 16 May 2019: “【HK$10,000 a year】Is early surrender worthwhile if the net tax savings make it worthwhile? Deferred annuity becomes a tax avoidance wonder product!”
The Standard 10 Sep 2019: “Insurance chief rejects tax loophole claim”
Apple Daily 9 September 2019: “Accused of abusing tax avoidance: BOC Life changes annuity terms”
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.
10Life Editorial Team
Our team of professional content researchers focussing on insurance
10Life Editorial Team
Our team of professional content researchers focussing on insurance
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10Life Product Comparison and 10Life Insurance Ratings are developed by 10Life Financial Limited, an authorised insurance broker company licensed with the Insurance Authority under License Number FB1526. 10Life Product Comparison and 10Life Insurance Ratings are developed for generic customer segments using mathematical calculations based on product information, facts and data, and are not influenced by any partnerships with or fees received from insurance companies. Any information on 10Life Platform ("10Life Information"), including but not limited to Product Comparison, Product Ratings, Blog Articles are intended for general education purpose and reference only. None of the 10Life Information is intended, nor should they be considered or relied upon, as regulated advice, insurance, financial, investment or professional advice, recommendation, approval, endorsement, invitation or solicitation in respect of any insurance, financial or investment products. 10Life Information does not take into account your individual needs. Reading 10Life Information should not be considered as conducting a suitability assessment, and is not sufficient to form the basis of any decisions to purchase any insurance products. You should rely on information authorised by insurance companies, carry out your own research and/or seek independent advice from licensed intermediaries before purchasing any insurance products or making any insurance decisions. While reasonable effort is used when collecting, validating and updating 10Life Information from various channels, none of 10Life Group and its subsidiaries, affiliates, agents, directors, officers and employees will be responsible for any liability, claim or loss arising from or associated with you using 10Life Information. No warranty, representation or guarantee is given by 10Life Group and its subsidiaries on the accuracy, completeness and timeliness of the information. If you have any questions on 10Life Product Comparison and 10Life Insurance Ratings, please email us at enquiries@10life.com
