A lifetime of security

It’s difficult to plan your retirement down to exact specifics; after all, no one is sure how long they’ll live, which makes it difficult to plan for how much money is needed.

This means retirees are always stuck with the fear in the back of their mind that their hard-earned superannuation may dry up while they’re still enjoying retirement.

Andrew Lowe, head of technical services at Challenger, said the secure and guaranteed income stream annuities provided give it a unique advantage when it comes to retirement planning.

“The first thing is the income stream component itself, we offer a range of either fixed and agreed terms for clients, so they can invest for a year or up to 50 years,” Lowe said.

“Or we also offer a range of lifetime income streams, which offer guaranteed payments for life.

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“Life is a really important element and that’s for as long as the client lives, if that be, a short term, average time, or they live for a really long time in retirement.”

The other key advantage is they aren’t linked to market performance. They won’t improve with the market, but they also won’t decline, providing stability.

“The payments that we offer at commencement are guaranteed and will only increase in accordance with the terms of the arrangement,” Lowe said.
Peter Rowe, general manager of Optimum Pensions, said what the firm’s annuities offer is different to a traditional annuity. 

“We’ve broken the annuity [offered by Optimum] down into two discrete elements, one being the lifetime guarantee of income and the other one is the investment component,” Rowe said.

“Traditional annuities are bundled up together and you pay a price, you buy the annuity and that’s it. We’ve actually split it up so the members actually choose their investments and yet we ensure the longevity elements, so they get the guaranteed income for life.

“A lifetime pension or annuity, you are locking money up for that lifetime period, but what you’re doing is buying an income that’s payable for life.”

Many firms work on the basis that you only put part of your retirement savings in the product.

Rowe’s assessment was that people had three main needs in retirement: regular income for life, access to capital and the opportunity to have some independence afterwards. 

“By mixing and matching the product you can actually get the right trade-off for a person and to secure that income for life,” Rowe said.

“Without it, so many people are going to run out of money before they die, unfortunately.”

Neekhil Shah, principal consultant at McGing Advisory, said that while annuities are supposedly risk-free because of their guarantee, in this low interest rate environment the assets that underpin annuities are not producing much income, as opposed to a balanced fund.

“Annuities are seen to be quite expensive, due to the profit margin and the low interest rate environment, so they’re not very popular for locking away savings,” Shah said.

“However, they are part of the solution, because they do provide guaranteed income for life.”

WORKING WITH  THE AGE PENSION

Lowe said annuities complement other retirement income sources, like super and the age pension, in retirement.

“If I look at the most important application, I see a lifetime income stream working hand-in-hand with the age pension a client will be eligible for,” Lowe said.

“That ensures no matter what happens, the client can always meet their required income needs in retirement.”

The age pension for a couple is about $36,000 a year, and for a single it’s about $24,000. Because this can be insufficient to get by on, clients looking to retire may decide to prioritise aiming for a certain level of income.

“A lifetime annuity allows them to ensure that come what may, they can meet those particular needs for as long as they live,” Lowe said. 

“If I look at the Association of Superannuation Funds of Australia (ASFA) retirement standard that’s $61,000 or so for a comfortable retirement for a couple.

“We’re not trying to provide all of that, we’re trying to provide a layout over and above the age pension to meet the essential expenditure of a client retirement.”

That combination of an account-based pension with an annuity could be the difference of how comfortable a lifestyle someone may have in retirement.

“I think there’s been a misconception, people think they’re just for rich, but they’re not,” Rowe said.

“We’ve done some modelling for people with around just $100,000 in a superannuation account when they’re retiring. If they just draw an account-based pension then that money is going to disappear after a while.”

The start of this financial year saw the introduction of new rules for social security means testing (the income and assets test) for lifetime income streams, which included lifetime annuities. 

The new rules mean 60 per cent of any amount invested in a lifetime income stream will be counted as an assessable asset until age 84 or for a minimum of five years, and just 30 per cent will be counted as an asset thereafter.

“Where a client is receiving a part-age pension, reduced because of the assets test, an investment in a lifetime income stream on or after 1 July 2019 can immediately increase their age pension,” Lowe said.

“Where a client is currently not receiving an age pension because of the assets test, an investment in a lifetime income stream on or after 1 July 2019 could reduce their assets sufficiently to ensure they are eligible for a part-age pension.”

Lowe said given the core strength of annuities is a secure income in their retirement income stream, this is not the best option if they’re happy with everything being variable.

“Say we take that ASFA comfortable standards of retirement and that’s about $61,000, if I work out what I think is about the recurring essential expenditure I probably land on a number that’s about $42,000,” Lowe said.

“Which is more than the current maximum age pension rate for a couple which is $36,000. The difference between $42,000 and $36,000 is what I want to spend each year in retirement.

“Could a retiree with $300,000-$500,000 afford $6,000 worth of CPI-indexed income payable for life? My answer is generally they can.”

FITTING TOGETHER

Annuities offer a defensive counter-weight to market linked investments which have higher returns, but lack stability.

“If I look at most clients who are getting advice, and they were implementing a retirement income stream, it’s rare there would be a recommendation to rely on one source,” Lowe said.

Managing director of Story Wealth Management, Anne Graham, said income in retirement comes from many sources, and may include dividends from shares, rental income, interest or even defined benefit pensions.

“Diversifying sources of income or ‘layering’ income can provide some protection and certainty in retirement,” Graham said.

“We need to think more creatively about retirement income as we are living longer, and our resources need to last as long as we do.

“The age pension is a safety net and over time it will be more difficult to qualify for, due to the ageing population and shrinking tax base.”

Graham said annuities can provide another layer of income and complement income from super/pension accounts and age pension. 

“If considering annuities for a client, we would allocate a portion of available funds to an annuity and certainly wouldn’t recommend investing all of a client’s portfolio in an annuity,” Graham said.

“Annuities can be blended with a more diverse portfolio of assets that might be skewed toward growth.”

As a financial planner, Graham said most clients would benefit from having a range of retirement income options, because clients’ needs vary and not all investments suit all people.

“Some clients prefer certainty and security of income and don’t like to take risks, others are very comfortable investing in share portfolios and relying on dividends,” Graham said.

“Annuities can provide an element of certainty to retirement income and may suit more conservative clients or those who receive part pension.”

Shah said since the Murray Financial Services Inquiry, the superannuation industry had shown it operated effectively in the accumulation phase, but now needed to do more for the post-retirement decumulation phase.

“It seems that we’re needing products to help people without risk of outliving their savings,” Shah said. “Which is great, people are living longer and healthier, but their savings are not keeping up.”

The Murray Inquiry led to a recommendation for the development of a product as part of the superannuation strategy to protect against this longevity.

“What has come about is this product, which is a comprehensive income product for retirement, which will help to provide longevity,” Shah said.

“Whether that’s through an annuity, or through an individual self-insuring themselves against living too long, or some sort of other longevity risk.”

MARKET OUTLOOK

According to Investment Trends, planners’ use of annuities had plateaued, although a greater offering of them in the market could change this. As it stands, the market is dominated by Challenger.

“The usage of annuities among Australian financial planners went through a growth spurt between 2012 and 2016, but has since remained steady with 44 per cent of planners saying they currently recommend annuities,” Investment Trends’ research director, Recep Peker, said.

“There remains strong desire to utilise annuities more, with 59 per cent saying would do so if all types of annuities were available to them.”
Peker said the most-sought annuities are lifetime fixed and variable annuities, which aligned with clients’ demand.

“From the consumer perspective, research reveals the top priority in selecting a retirement income product is income that lasts for life – ahead of guaranteed minimum income payments,” Peker said.

Shah said the discussion around annuities and the overall post-retirement space is signalling a fundamental change as Australians are aging.

“We speak to super funds regularly, and more funds are thinking about products in tandem with financial advice and member experience,” Shah said.

“This was not the case historically and we were pleased to see the change.”

Lowe said there is a huge opportunity because there is a significant under-representation to secure income in retirement.

“The average retiree these days gets to retirement and converts the accumulated superannuation into an account-based income stream which is market-linked,” Lowe said.

“I think increasingly more of those clients are allocating part of it to secure or guaranteed income streams and I anticipate that grows over time.

“If I look at product developments that have come to market in the last decade that will roll through from 1 July this year, we are looking at more flexible, guaranteed income streams than we’ve ever had.”

Rowe said because the government introduced a change in 2017 to open the market up so super funds could offer more products, the market has already changed drastically.

“They’ve been talking about it for a while, but what you’ve seen since then is the Australian Prudential Regulation Authority (APRA) looking at member outcomes where the funds have not to just look at the outcomes for people in the accumulation phase, but also for outcomes for retirees. Funds are going to be expected now to develop a retirement income framework.

“What you’re seeing is the beginning of that change, we’re engaged with a number of funds and we know a number already have set budgets in place for the next financial year to look at how they’re going to implement retirement products for themselves.”