Andrew is retired he has no pension but has capital of500000...

Andrew is retired. He has no pension, but has capital of $500,000. He is considering the following options for using the money: 1. Purchase an annuity from an insurance company that will pay a level amount for the rest of his life. 2. Purchase an annuity from an insurance company that will pay an amount that increases with the cost of living for the rest of his life. What are the advantages and disadvantages of each?

Transcript

00:01 So here i'm going to break this problem up into two parts.

00:03 We've got this money.

00:04 We have no pension.

00:05 We want to fund retirement.

00:06 And we're going to consider whether to buy an annuity.

00:08 So first, should we buy an annuity? i want to talk about that very briefly, right? the whole point of annuity is to remove life expectancy risk.

00:19 Right? that's definitely one thing.

00:25 The annuity will pay you as long as you're alive.

00:28 So if you live a very long time, the annuity means you will not run out of money, right? very basic.

00:35 So it gets rid of this life expectancy risk.

00:40 It also removes sort of stock market risk.

00:46 When you buy the annuity, you sort of lock in your return, right? you say, i'm giving you this much up front to deliver these payments, as opposed to if you invest it yourself, you might be subject to timing effects or crashes in the stock market.

01:02 So you're removing some risk from yourself.

01:05 But what do you get to remove risks, right, is you pay a premium, right? the person who offers the annuity needs to make at least a little bit of money, right? they are selling you insurance.

01:19 You are buying an insurance product, and the cost for the insurance product is a premium.

01:23 The other thing that dissuades a lot of people from buying an annuity is that lack of bequest.

01:31 Normally people worry about leaving money to their kids, but when you buy an annuity, that money is gone...

Question

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