Question

There are various financial instruments that could be used as a form of post retirement income.
Assess the pros and cons of using:
(a) an annuity

(b) coupons from long term bonds

(c) dividends from stocks

Answer 1

a) Annuity: Its like a contract between the customer and the insurance company where we pay lump-sum amount for a number of years to form a corpus from which we will receive annual payments like our salary in our retirement years. For eg: We save $1000 monthly for 30 years earnings 10% per annum we will save a amount of 2,260,488 at the end of 30 years, we will receive 21,814 every month for the next 20 years. The pros are its like earning a salary even after retirement and having a constant income. We can handle and cover all our expenses. Cons: If we need a lump-sum amount for emergency we will not be able to withdraw from it. Any major amount required we will have to borrow it.

b) Coupons from long term bonds: Its a mixture of constant income and total principle value invested in the bonds. Its pros are we have constant income to the tune of coupon payments and if we need any major amount we can sell the bond. The coupon payments are not as big as annuity because it will give us the percentage of the bond value, it will not be compounded annually or monthly. The principle value invested will be there intact but there will be not value addition to the principle amount, if we check its actual value it will be less than the market value because of inflation.

c) Dividends from stocks: This income is the most unpredictable of all the investments as if the company has good profits and if it decides to share the profits then only we receive the dividends, if the firm has more projects in hand than we will not receive the dividends. If we invest in a firm with constant dividend policy then we may receive dividends every year. The amount invested in this firm will rise as the profits and reserves of the firm rise so the returns on the stock will be much higher than the inflation and the government rate of return.