Planning for a financially secure retirement has become much more difficult for Baby Boomers in recent years. Wildly fluctuating stock markets have made returns from share portfolios hard to predict, and ‘lower for longer’ interest rates have eaten into yields from term deposits and bonds.
As many superannuation funds have some exposure to volatile stock markets, it’s worth investigating other retirement income solutions.
“The current volatility only increases the need for sound retirement planning,” said Graham Heunis, head of retail banking and wealth management at HSBC Australia.
It pays to get independent, professional advice on planning retirement finances, as it is an extremely complex field – and one where mistakes can be costly.
A professional can help retirees determine whether they qualify for a full or part Age Pension and a Commonwealth Seniors Health Card or Pensioner Concession Card.
They can also help retirees factor in assumptions on what their health (and that of their spouse) is likely to be like in the future, the damaging effects of inflation on their portfolio, and whatever legislative changes the government may introduce that may affect their investments.
Without careful planning and quality advice, retirees are exposed to the very real risk of outliving their savings. However, a well-structured investment portfolio which includes an element of guaranteed income can significantly increase the likelihood of meeting essential income throughout a retiree’s life.
One type of guaranteed income to explore with your financial adviser is annuities, which complement shares and other investments subject to market fluctuations.
Annuities are financial products that pay a guaranteed, secure income that can keep pace with inflation. The income is generally tax free if you’re over 60 and investing your superannuation money. Some annuities may also help improve outcomes from seniors benefits, such as the Age Pension and the Commonwealth Seniors Health Card.
“The main benefit of an annuity is certainty,” says Paul Swinhoe, a partner at Deloitte Actuaries & Consultants.
“That is, a paycheque comes in regularly every month. It’s a big plus for people who, as they get older, are less and less willing and able to manage their own financial affairs.”
A retirement strategy that guarantees a regular income lines up with the desires of the majority of seniors canvassed in a research paper produced last year by National Seniors Australia and Challenger.
The proportion of seniors who thought the role of super should be to provide a lump sum of wealth at retirement was surprisingly low (less than 5 per cent across all age groups and incomes), while at least 75 per cent thought the purpose of the superannuation system was to provide a regular income for the whole of retirement.
“We’re seeing a shift in investor behaviour from a returns mindset to income certainty and cashflow as the main priorities,’’ says Paul Rogan, Challenger’s chief executive, distribution, marketing and research.
“Since retirees are no longer working, products like annuities are very attractive because they provide peace of mind that essential spending needs in retirement will continue to be met.”
Annuities have long been a popular tool in the arsenal of retirees in other countries such as the US, but Australians are only now catching on in significant numbers as financial advisers become more familiar with their use as part of a portfolio of different retirement income assets.
“Planners are becoming proficient in recommending annuities, with more finding them easy to understand and use,” said Recep III Peker, head of research for wealth management at Investment Trends.
There are two main types of annuities, lifetime annuities and fixed term annuities. As the name suggests, a lifetime annuity delivers a guaranteed, regular cash flow for life regardless of how long you live, or how investment markets may perform.
When purchasing a lifetime annuity, you also have the option of providing payments for the lifetime of a second person, such as your spouse. This can be done either by nominating a person who will receive your payments should you die, or via joint ownership.
Protection against inflation is an optional extra: you can choose to have your payments remain constant for life or have them partially or fully adjusted in line with changes in the Consumer Price Index.
Although they are designed to last as long as you do, some lifetime annuities do provide early withdrawal options should your circumstances change.
However, if you do withdraw from your annuity, you may receive back less than you invested originally and less than you would have received had you held the annuity for life. As well, some lifetime annuities allow you to remove the ability to withdraw in the future in return for higher regular payments for life.
“The older you are when you buy a lifetime annuity, the larger the annual income you will get, as it will be based on an equation that takes in the amount invested and your average life expectancy,” Swinhoe explains.
Fixed term annuities
The second type of annuities, fixed term annuities provide a steady stream of payments over a fixed period of your choice, typically anything from one to 50 years.
As with lifetime annuities, you can select the payment frequency that suits you best, be it monthly, quarterly, half yearly or yearly.
You can also have the choice of how your original capital investment will to be returned to you. With a Challenger annuity, for example, the capital is repaid either throughout the investment term as part of your regular payments, as a lump sum at the end of the investment term, or a combination of both.
If you should pass away before your fixed term is up, your estate or beneficiaries generally have the option to either continue to receive payments until the end of the term or withdraw the annuity early and have it paid as a lump sum.
Deferred lifetime annuities
In some parts of the world, a specialised product called a deferred lifetime annuity is available.
A DLA is a lifetime annuity where the payments do not start immediately. For example, the product might be purchased at age 65 with payments commencing at, say, age 85 and continuing for life.
DLAs are not currently available in Australia, but this may soon change as a result of the Government’s promised tax and superannuation reviews.
Ask a professional
By working together with a financial adviser, you can design the best possible retirement portfolio for yourself after taking into account your personal circumstances.
A financial adviser can help you understand how an annuity could fit within your investment portfolio and how to select the appropriate investment amount, term and how your capital is returned.
Your financial adviser can also help you think more generally about your budget in retirement, including how to identify your expenses and then structure your investments so that you’ll have income to meet them, and whether you can improve your social security entitlements by using different investments.