Riding the retirement roller-coaster

When share markets resemble a roller coaster ride, you could say that retirees have the most to lose.

Retirees generally don’t work and so have a limited amount of assets to fund their retirement, it’s difficult to build more assets in retirement, and retirees want to protect the wealth they have accumulated.

Retirement plans will often feature allocated pensions. These products have an array of investment options and when the investments chosen perform well, clients can be very satisfied with their investment. However, it’s important to remember that with allocated pensions, the investor wears the investment risk.

In times of market volatility, clients are often duly concerned about their allocated pension, especially when it’s their main investment vehicle and has large exposure to poorly performing assets.

When the market experiences a downturn, clients may be forced to draw down their capital, which in turn reduces the value of their allocated pension.

Just as after the September 11 terrorist attacks, when there was extreme market volatility, we’re now seeing a take up of annuities. Why? It’s all a question of timing — annuities and allocated pensions both go through a cycle of popularity; when times are great, allocated pensions are the choice, when times are tough, there is a flight to annuities.

The attraction behind an annuity is the nature of the guarantee. When a client starts an annuity they lock in a rate of return (i.e, yield), this is guaranteed for the term or lifetime of the product. Establishing a fixed return means the product provider wears the investment risk, not the client. So the client will continue to receive income payments for the entire term or for their lifetime regardless of what’s happening in the market.

Other reasons for recommending an annuity include:

> in the current environment of rising interest rates, clients get better yield rates from annuities. This means clients could get more guaranteed income each year from their annuity;

> clients aged 60 and over can enjoy tax-free income payments when they purchase an annuity with superannuation money; and

> annuities can provide for a client’s lifetime, which can ease the financial strain of living longer than they have budgeted for.

Annuities come in all shapes and sizes to fit the needs of many different clients: long term, short term and lifetime. Clients can choose to have all of their capital returned at the end of the term, or can nominate to distribute income payments on a yearly basis using both income and return of capital. Payments can also be indexed in line with inflation.

A diversified strategy

As markets always go in cycles, it’s important to consider a diversified retirement strategy for your clients.

Clients can have a portion of their assets (and income providing ability) protected by an annuity and also have the potential to access extra return from their allocated pension (if they have exposure to growth options such as shares and property).

The allocated pension is also commutable, which can ease the non-commutable nature of the annuity.

This approach is one that some advisers use. With an annuity, a client will know the amount of income they will receive, as the rate is guaranteed. This can be used to fund fixed living expenses such as ongoing housing expenses, energy, food, personal care, transport, clothing and fixed leisure expenses. The income from the allocated pension can be used for variable expenses such as replacing furniture, household appliances, maintaining the garden, major home repairs or a holiday.

Carly O’Keefe is the executive manager of super and investment solutions at CommInsure.