How Does a Tontine Work? - SmartAsset

A tontine is a shared annuity where a group of investors pools money and receives regular dividends from the investment. What sets tontines apart is that as participating investors die, their share of the returns is split among the surviving investors. Tontines have been around for hundreds of years; in their early days, they were used to finance wars. However, they have been used for a variety of other purposes, including as retirement investments and as a means to finance new buildings.

If you are thinking of investing in a tontine or any other annuity, consider seeking the counsel of a financial advisor.

How Tontines Work

Tontines are a variation of the annuities many people purchase today. They work as shared annuities where investors contribute a lump sum upfront and receive dividend payments in proportion to their contribution. Then, as investors die, their share of the dividends is distributed to the surviving investors.

When there is only one investor remaining, they receive the entirety of the dividend. Then, when the last remaining investor dies, the investment would return to the government or company that created the tontine. One important note about tontines is that investors only receive interest; the principal is never repaid.

Because younger people generally have a longer life expectancy than older people, tontines historically had age tiers, where no participant in each tontine could be more than 10 years apart. However, a twist on the scheme rewarded older participants with a higher interest rate.

Tontine History

In the 1600s, kings were in need of ways to fund wars, yet they struggled to find the financing they needed. Raising taxes, for instance, was unpopular, and bonds were expensive. At the time, kings such as Louis XIV badly needed an alternative form of financing. The first tontine was proposed by Lorenzo de Tonti in Italy in 1653 as a possible solution. Ultimately, the investment would be named after de Tonti. It is not known whether de Tonti came up with the scheme on his own; there is some belief that the idea is a variation of an earlier investment scheme that was popular in Italy and Germany.

Whether the idea was original or not, the name stuck, and tontines became popular in the late 17th century (although not until after de Tonti’s death). Tontines remained popular throughout the 18th and 19th centuries and into the early 20th century. However, governments mostly stopped using tontines in the 18th century; they mostly remained on a smaller scale to fund specific projects, such as buildings.

One of the later uses of tontines was by the insurance industry in the United States, beginning in the mid-19th century and lasting until the early 20th century. They were introduced in the U.S. as a way to sell more life insurance; in fact, tontines are often credited as giving rise to the modern life insurance industry.

Tontines fell out of favor in the U.S. shortly after the turn of the 20th century, however, due to a series of scandals. You might hear that tontines are illegal in the U.S., and they certainly aren’t as popular as they once were. However, only two states (Louisiana and South Carolina) explicitly prohibit them in state law.

This has given rise to speculation that tontines could see a resurgence, particularly as pensions disappear and many people worry that annuities will be insufficient to cover their needs long term.

Reasons for Investing in a Tontine

There are several reasons one might consider investing in a tontine. As mentioned previously, one of the main reasons people don’t like annuities is because they might worry that the annuity won’t be enough to cover their needs. But there are other reasons tontines may be attractive:

The “break-even” point: One of the worries about annuities is that participants won’t live long enough to break even. For instance, a $25,000 annuity might pay about $105 per month for a 62-year-old male, or $1,260 per year. Hence, it would take years to break even on the cost of the annuity – assuming you live long enough to break even at all.
Increasing expenses: People tend to have higher medical expenses the longer they live. A tontine can help offset that risk because you receive more interest when other members of the tontine die. Hence, your payments from the tontine will generally increase the longer you live.
Lower administrative costs: One of the problems with annuities is they can be costly to administer, and that reduces the payouts to members. The high cost comes from the risk the insurance company assumes when issuing the annuity. Tontines don’t depend on a middle man in this way, which reduces their administrative costs and increases payouts to participants. According to reporting from the Washington Post, that might amount to 10% to 20% larger payments.

The Bottom Line

Tontines are a kind of shared annuity where groups of investors pool their money and receive dividends in return. As participants die, their share of the dividends goes to the remaining investors. As a result, each member’s dividends increase as fewer and fewer investors remain. With pensions disappearing and some people remaining averse to annuities, tontines are seen as a possible alternative way to provide financial security to retirees in the U.S. today.

Tips for Retirement

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