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The role of annuities in retirement

Life expectancy is on the rise, but living longer and comfortably in the ‘Third Age’ brings with it new financial challenges.

According to the Federal Government’s 2015 Intergenerational Report, a person who is 65 today can reasonably expect to live to the age of 90, which means living 25 years or more in retirement.

With this in mind, the government, along with many superannuation funds and financial advisers, are actively looking for better ways to help manage people’s income needs in retirement, ensuring they don’t outlive their savings.

According to a 2015 report by National Seniors Australia (NSA), a majority of seniors aged 50 years and over believe that the goal of superannuation is to provide a regular income for the whole of retirement. It also found seniors attach significant importance to guarding their spending power against inflation and market fluctuations.

Annuities are a reliable option for retirees looking for a secure income stream that is protected from share market ups and downs.

By delivering a regular cash flow for a fixed term or for life and with the option of indexation to protect against inflation, annuities are an attractive offering for anyone concerned about outliving their savings.

Planning to meet retirement needs

Annuities can help seniors adapt to a changing retirement landscape.

For those who entered the workforce after the introduction of compulsory superannuation in the 1990s, funding retirement presents a different set of issues than for older Australians, who grew up before the national system was established, when there was a greater reliance on the government pension.

Because the balance of responsibility for funding retirement is shifting from the public to the private sphere, people will retire with larger superannuation balances than in the past. In fact, the total superannuation balance in 2013-2014 for a household headed by a person 60-64 years of age was around $355,000, well above the average of $237,600 two years earlier.
Source: ASFA Superannuation account balances by age and gender – Dec 2015.

But with higher superannuation balances comes the need and the responsibility to manage these funds effectively. Planning for a financially secure retirement becomes essential.

As part of that planning process, it is especially important to make the distinction between life expectancy and lifestyle expectancy, that is, how long you expect to live versus how long you expect to maintain your lifestyle in retirement, and plan accordingly.

To help this process, Challenger offers a useful lifestyle expectancy tool designed to help people aged 56 and over understand whether they can afford to maintain a comfortable standard of living in retirement based on the Association of Superannuation Funds of Australia (ASFA) Retirement Standard guideline.


The importance of budgeting

The Association of Superannuation Funds of Australia (ASFA) calculates that, for those aged around 65 years, to secure a comfortable lifestyle in retirement, a couple would need to have an income stream of roughly $59,236 per year. For a single retiree, that figure comes to $43,184.

But the NSA report also revealed that seniors may not be taking adequate steps to plan their finances for retirement.

It found that around 40% of seniors had no specific plan for later life expenses, such as medical treatment, and that two-fifths of seniors are not using a formal budget to manage their household expenses. The report also found that those aged 50 years and over were underestimating how long they would live by up to seven years.

With longer life expectancies and poor budgeting, the risk of running out of money in retirement increases.

Creating a secure income stream

Annuities can offer peace of mind for those looking for a secure income stream in retirement.

An annuity is a secure financial investment, which delivers a guaranteed, regular income stream for a fixed term or for life, and can be indexed to keep up with the rising costs of living. A key benefit is the protection against fluctuations in the share market. Your payments are guaranteed, regardless of what the share market is doing.

In the case of lifetime annuities, they can manage the risk of outliving your retirement savings by paying a regular and reliable income for the rest of your life.

The appeal of an annuity is underscored by their financial attainability and practicality; no associated management fees deducted from the account (with the possible exception of those billed by a financial adviser), and if you’re over 60, the payments are tax-free if investing with your superannuation money.

Thanks to their reliability and regularity, annuities can act as a retiree’s ‘paycheque’ in retirement.

Layering your retirement income

One of the key principles in delivering sustainable and secure long term retirement income is to create a well-structured, layered investment portfolio.

The income layering approach is where income streams are ‘layered’, so that more secure income covers your essential costs of living, while market-linked income funds cover any discretionary spending.

In constructing a layered income stream, annuities present as a key product in a retirement portfolio and can be the bedrock on which a diverse allocation of other investments can be based.

Acting as the first layer, a lifetime annuity combined with any Age Pension benefits you are entitled to can cover ‘essential’ costs, such as food, clothes and medical expenses.

Remaining savings can then be invested in other assets, such as account-based pensions or term annuities, which provide a second income layer to pay for ‘desirables’, like holidays, entertainment and dining-out, or provide longer term growth.

Income layering gives retirees freedom to enjoy their retirement by offering the peace of mind of knowing their income needs in retirement are taken care of.

Planning for retirement can be a complex exercise so it’s a good idea to seek professional advice. A qualified financial adviser can develop strategies to help you achieve your retirement goals and live the retirement lifestyle you’ve always wanted.