How guaranteed income products work
Lifetime guaranteed income products have two components:
- An account-based pension.
- 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.
Sounds great, right?
In theory, yes. These new income-guarantee products give retirees a sense of stability, with a set annual income that will never decrease. But there are a few catches.
- They have high fees.
- There are limits on the amount you can draw down each year.
- They aren't indexed to keep up with inflation.
So why choose guaranteed income?
For most of us there's 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.
A poor investment result in the early years of retirement or just before retirement may mean your savings never recover.
If, for example, you were drawing down retirement income during the 2008 GFC, your account balance could have taken a catastrophic hit.
There's a limit on how much you can draw down annually on this type of retirement plan. This generally varies between four and five per cent of the amount of your guarantee base (i.e. the start value of your investment).
So on a $100,000 investment, you can draw down around $5000 per year. When the average personal savings for those aged 55–64 is $229,000 for males and $149,000 for females, that equates to a pretty frugal yearly budget.
Your investment balance is reviewed yearly, and if it's higher than the original investment, the guaranteed base will increase in line with the new balance. But there's no guarantee your original investment will actually increase in value.
These products don't automatically index against inflation, so you're left without an important safeguard. And using CPI figures from recent decades as a reference, $5000 today is probably only equivalent to $2900 in 20 years' time.
They may look pretty similar, but income-for-life products from providers like AXA, ING and Macquarie have important differences.
- The fees they charge and the maximum amount you can draw down each year vary.
- You may have to invest your money through the company's allocated pension product.
- Some companies may only offer the Lifetime Income Guarantee through their self-managed superannuation fund structure.
Case study 1: Lifetime guarantee plans
Sally and Tom are 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 would receive an annual income of $15,000 from ING or AXA, or $18,000 from Macquarie.
- Macquarie applied a lifestyle bonus rate which may decrease after the first five years.
- The guarantee fee ranged between 1.1% and 2.15% per year. This may not seem like a lot, but when applied to Sally and Tom's example it's between $3,300 and $6,450 in the first year alone.
Case study 2: Lifetime annuities
Lifetime annuities also provide an income-for-life product, though their popularity has waned significantly since the changes to the government's means test for the age pension came into effect in 2004 and again in 2007.
- If Sally and Tom invest the same $300,000 into a lifetime annuity with CommInsure, 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.
- 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.
Where to from here?