Income for life?

We look at whether income-for-life retirement products are as good as they claim.
 
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01 .Introduction

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If you and your spouse are both aged 65, there’s a 50/50 chance one of you will live till 94. This means the chances of running out of your savings during retirement are greater.

New retirement products have emerged that promise to pay you a set amount of “income” for the rest of your life. They have two components: an account-based pension and a lifetime income guarantee offered by a life insurer. You draw income from the account-based pension and pay a fee for the lifetime income guarantee. If your account runs out of money, the life insurer continues to pay you income until you die.

In principle these new products give retirees a sense of stability as the annual income from these products is set and will never decrease. However as well as the high fees charged by these products, there are also some limitations to them such as the amount you can draw down and the fact they do not automatically account for the effects of inflation.

 
 

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Why are these products needed?

There is a fundamental difference between the savings phase, when you're heading towards retirement, and when you actually retire and begin drawing down on your savings.

If your investment performs badly in the early years of retirement, you may never recover. For example, if you were drawing down retirement income (dependent on investment returns) during the 2008 global financial downturn, this would have reduced your account balance significantly. This kind of volatility in the market is less important in the years leading up to retirement, since it's a good return over time that really matters. 

Graphs below show the adverse effect on the pension account if there is a -20% pa return for the first two years of retirement as compared to the negative return being for the last two years of the retiree's life.

There are a few limitations with these products:

  1. There is a cap on how much you can draw out every year. This varies between four per cent and five per cent of the amount of your guarantee base, which starts as the value of your investment. If, for example, you invest $100,000, you could draw down $5000 (five per cent) per year. So considering the average personal savings (including superannuation) for those aged 55-64 is $229,000 and $149,000 for males and females, these products alone will not be able to provide an adequate income.
  2. They do not automatically account for inflation. For example, using the past 20 years’ consumer price index (CPI) figures as proxy, $5000 today is only equivalent to $2900 in 20 years’ time. There is a safeguard within these products whereby every year your investment balance is reviewed and, if it is higher than your original investment, your guarantee base will increase in line with the higher investment balance. However, there is no guarantee that your original investment actually increase in value and thus the amount you draw down per year is not guaranteed to increase every year and/or in line with inflation.

How do they compare?

Although apparently similar, the products by AXA, ING and Macquarie have their differences. The fees they charge and the maximum amount you can draw down each year vary (see table). You need to invest your money through the allocated pension product by AXA and ING, whereas currently Macquarie only offers the Lifetime Income Guarantee through the self-managed superannuation fund (SMSF) structure.

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Case Study: Sally and Tom

The calculations below are based on a couple, Sally and Tom, both 65 and retiring this year. Tom is expected to live to age 87 and Sally to age 90. They live in their own home and Tom has personal savings of $300,000, while Sally has $200,000. They’ve decided to invest $300,000 into one of these “income for life” products while investing the rest of their savings elsewhere.

In the first year of investment, Sally and Tom will receive an annual income of $15,000 from ING and AXA, and $18,000 from Macquarie. Macquarie applies a lifestyle bonus rate which may decrease after the first 5 years. The guarantee fee ranges between 1.1% and 2.15% per year, this may not seem like a lot but when apply to Sally and Tom’s example it is between $3,300 and $6,450 in the first year alone.

Lifetime annuities also provide an income for life, although their popularity has waned significantly since the change in the government’s means test for the age pension came into effect as at 20 September 2004 and 2007. If Sally and Tom invest the same $300,000 into a lifetime annuity with CommInsure, which is the only provider of lifetime annuities at the moment, they will receive $18,863 per year for the rest of their lives.

The downside of the lifetime annuity is that Sally and Tom are unable to withdraw from the annuity outside the guaranteed period. In addition when they both pass away, if they have chosen a nil guaranteed period or the guaranteed period has expired, there will be nothing left for their estate. For more information on alternative pension products visit the Australian Securities and Investments Commission's consumer website.

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Where to from here?

Before making any decisions about your retirement finances, consult a professional such as an accountant or financial advisor, or make an appointment with Centrelink for advice on planning the most favourable retirement. The National Information Centre on Retirement Investments (NICRI) is another government-funded service that can assist you.

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