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No financial needs analysis is required for qualifying deferred annuities: how can you avoid risks and maximise tax deductions?
As the novel coronavirus spreads, customers and insurance advisers have been unable to meet in person in order to reduce the risk of infection. The insurance industry is facing unprecedented difficulties. In February, the Insurance Authority (IA) introduced temporary facilitation measures allowing consumers to purchase tax-deductible Qualifying Deferred Annuity Policies (QDAPs) and Voluntary Health Insurance Scheme (VHIS) policies without meeting an insurance adviser or conducting a financial needs analysis. The measures will remain in place until 31 March, enabling consumers to take out policies before filing their tax returns and enjoy tax deductions. As the epidemic continues to spread, Hong Kong people are naturally reducing face-to-face contact in order to stay strong in the face of adversity. However, without a financial needs analysis, could consumers be more exposed to potential risks? Therefore, 10Life reminds everyone that they should understand their personal needs, financial situation and ability to pay premiums before taking out long-term insurance products, such as the QDAPs currently featured prominently in advertisements, to avoid rushing to save tax and regretting it for the rest of their lives. In this article, the author will also share the key considerations when selecting a QDAP.
Potential risks of QDAPs should not be overlooked when no financial needs analysis is completed
Have you noticed that, traditionally, when taking out a long-term insurance product, you (or your insurance adviser on your behalf) are required to complete a financial needs analysis form? This asks about the purpose of taking out the policy, your investment preferences, how long you expect it to take to realise the policy benefits, and how much and for how long you are willing to pay premiums. This is a measure implemented by the IA to protect consumers and assess whether you are suitable for the product (see Note 1). However, with COVID-19 raging and customers and insurance advisers unable to meet in person, the IA has introduced temporary measures waiving the requirements for face-to-face meetings and financial needs analyses.
For VHIS policies, waiving the financial needs analysis does not pose particularly high risks to policyholders, because medical insurance is renewed annually. If a policyholder is young and healthy, switching to another medical insurance product in the second year is not especially difficult. Conversely, waiving the financial needs analysis poses considerably higher risks for those taking out a QDAP, because the policy term of a QDAP is at least more than ten years and may last a lifetime. If you regret taking out the policy after the event, it may genuinely be too late to turn back. Therefore, everyone should first understand the risks of QDAP products!
Risk 1: Different QDAPs serve different purposes
Although taking out a QDAP can increase returns through tax deductions, QDAP products offered by different insurance companies are positioned differently. Some are medium-term products designed to maximise medium-term returns; others are long-term products primarily intended to hedge against longevity risk. Some products do not fit clearly into either category, and their positioning is currently uncertain.
Risk 2: Savings involve investment risks and non-guaranteed elements
Deferred annuity products are essentially savings insurance. They include guaranteed and non-guaranteed returns, with the non-guaranteed returns affected by the economic environment, the insurance company’s investment performance and its bonus policy.
Risk 3: Risk of stopping premium payments or surrendering early
When the economy declines, are you concerned that your income may fall and that you may be unable to continue paying premiums? If you stop paying premiums midway through the policy term, a policy loan may be activated automatically for some products. If the loan amount, interest and other charges exceed the policy’s cash value, the policy will lapse. If you surrender the policy in its early years, the amount you can recover may be substantially less than the premiums paid. Therefore, even if you are eager to save tax by taking out a QDAP today, you must ensure that you will have sufficient ability to pay premiums in the future.
Understand the key points when taking out a QDAP to increase returns through tax deductions
Although QDAPs carry potential risks, the tax benefits are highly attractive, particularly for salaried workers, as if the Government were “subsidising” your savings. In fact, as long as you choose the right product, you can also save tax through a QDAP and achieve your medium-term savings or long-term retirement objectives. Before the end of March, policyholders will not be required to complete a financial needs analysis, making it even more important to do your homework and select a QDAP carefully. The following factors are worth considering:
Consideration 1: Choose a QDAP that meets your personal needs
You should understand the income period of the deferred annuity. Depending on the policyholder’s premium payment period, different products offer different income period options. If your objective is medium-term savings returns, a product that starts paying the annuity earlier and completes the payments sooner (possibly before age 65) will generally offer a more attractive rate of return. If you wish to create a regular income stream for retirement, pay attention to which products begin paying the annuity between ages 60 and 65 (or at your ideal retirement age), how long the income period lasts, and whether it matches your expected lifespan.
Consideration 2: Compare the guaranteed internal rates of return of QDAPs
The internal rate of return (IRR) is an important indicator for measuring the returns of a QDAP. Returns are divided into guaranteed and non-guaranteed components. 10Life places particular emphasis on guaranteed returns, which insurance companies must provide to policyholders and are contractually binding, with no room for embellishment.
10Life has found that the guaranteed internal rates of return of QDAPs on the market vary considerably. For example, assuming that a policyholder’s objective is medium-term savings, premiums are paid for five years from age 45, and the policy is held for 15 years, we can calculate the guaranteed IRR of the product at age 60 based on the annuity income received (if any) and the cash value upon surrender at that time. After taking tax benefits into account, the IRR of the QDAP increases significantly.
Product name | Annuity income period | Guaranteed IRR at age 60 (product returns only) | Guaranteed IRR at age 60 (including a 17% tax band) |
Top three products in the market by guaranteed returns | Age 50–60／65 | 2.9% - 3.0% | 4.9% - 5.3% |
AXA “Live Well” Deferred Annuity Plan | Age 55–65 | 1.5% | 3.1% |
Manulife ManuLeisure | Age 55–85 | 0.7% | 2.2% |
PRURetirement Deferred Annuity Plan | Age 50–70 | 0.4% | 2.2% |
AIA Deferred Annuity Plan | Age 55–64 | 0.3% | 1.9% |
1. The above product information was updated on 5 March 2020.
2. The guaranteed internal rate of return is calculated based on the entire cash flow arising from premiums paid from age 45 to age 60, together with the annuity income received (if any) and/or the cash value upon surrender at that time.
Readers should note that the chart above only shows the guaranteed IRR at age 60. As the policy term increases, the product’s guaranteed IRR is expected to rise until the annuity payments are completed.
Consideration 3: Understand the impact of surrendering a QDAP early
As illustrated above, we found that the losses incurred by policyholders upon early surrender vary substantially among different QDAPs. Assuming that the policy is surrendered one year after it is taken out, the policyholder could lose approximately 24% to 80% of the premiums paid. Therefore, you should compare products carefully, ensure that you can afford the premiums, and only then consider buying one.
[For maximising tax deductions and savings returns: Compare Qualifying Deferred Annuity Policies]
[For retirement protection and hedging against longevity risk: Compare Qualifying Deferred Annuity Policies]
In addition to introducing temporary facilitation measures waiving the financial needs analysis, the IA has also extended the cooling-off period for QDAP and VHIS policies to 30 days (Note 2), as postal delivery of documents takes time. Make use of the cooling-off period to study the policy carefully.
Notes:
- The Insurance Authority’s Guideline 30, “Financial Needs Analysis”.
- Previously, long-term insurance policies had a 21-day cooling-off period. Policyholders have the right to cancel the policy during the cooling-off period and request a refund of the premiums paid. Please refer to the “Code of Practice for the Administration of Insurance Agents”.
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
