Five ways lifetime annuities improve retirement
|For financial adviser use only|
One of the biggest challenges of retirement planning is dealing with unknowns. Annuities provide financial advisers with the ability to deliver peace of mind in five key areas of a retirement income strategy.
One: Help clients cover their essential living expenses for life
As a financial adviser, being able to offer certainty is invaluable to clients. Unlike other investments that can fluctuate or income that could fail over time, an annuity is a secure investment that provides regular payments that are guaranteed for life, regardless of how long a client lives or how investment markets perform.
Research tells us that the average 65-year old underestimates their life expectancy by almost five years1.
With an annuity, you can protect against longevity risk to deliver peace of mind that a clients’ retirement income will last even if they live longer than expected. An annuity can also help protect against market risk and the impact of varying investment returns (sequencing risk). In addition, the knowledge that annuity payments are known and guaranteed can help clients’ better deal with the impact of market volatility in other parts of their portfolio.
Two: An additional layer of income protection can give retirees more confidence in their spending
A retirement income strategy that relies on income from the Age Pension, topped up with other income (such as income from an account-based pension) is common. However, this strategy can leave retirees exposed to the risk of running out of income in the later stages of retirement – in what we call the ‘retirement danger zone’. An income layering strategy can solve this problem. By introducing (or layering) a number of income sources, including guaranteed lifetime income, in your clients’ retirement income portfolio, you can ensure your client has some safety net income to help cover their expenses for life, and growth assets that have the potential to produce higher returns.
Used as part of an income layering strategy, an annuity can top up your clients’ pension payments to meet the cash flow they need for essential living expenses. If their account-based pension runs out, your client will have another source of income to cover their essential living expenses.
In addition, an annuity can provide protection against inflation risk. Even small increases in inflation over time can erode the value of your client’s investments and standard of living if the investments don’t keep pace. Payments from lifetime annuities can be linked to yearly inflation changes, helping to protect your clients’ spending power.
Three: Annuities may entitle your clients to an immediate increase in their Age Pension – or the ability to access it for the first time
The changes to Centrelink’s means testing rules in July 2019 brought more opportunities to create attractive means testing outcomes for retiree clients who have a lifetime annuity.
A quick recap: Only 60% of your client’s annuity payments will be assessable under the income test. For the assets test, generally 60% of the purchase price will count as an asset through to age 84, or for a minimum of five years. Beyond this point, only 30% of the purchase price will be assessable. So how can these concessions work for your clients?
- For clients receiving a part-Age Pension: Where a client is receiving an asset tested part Age Pension, each $1,000 of assessable assets over the lower assets test threshold reduces their Age Pension entitlement by $3 per fortnight, or $78 p.a. For asset test sensitive clients who invest $100,000 in a lifetime annuity, their assessable assets will immediately reduce by $40,000. This $40,000 reduction in assessable assets could, in turn, increase your clients’ Age Pension by $3,120 (or 3.12% of the $100,000 invested) in the first year alone.
- For clients who do not qualify for the Age Pension: A lifetime annuity could reduce a client’s assessable assets below the assets test cut-off and allow them to access the Age Pension and Pensioner Concession card for the first time. Whilst not all clients will be in a position to benefit from the Age Pension, for some this additional income could have a big impact.
When it comes to a defensive strategy, clients typically think of cash or fixed interest which have the role of providing stability against market movements, and an income for clients. Allocating a portion of your clients’ defensive assets to an annuity offers clients even further diversification in their retirement income portfolio, whilst providing them with a number of additional benefits:
- competitive payments when used as an alternative to cash, term deposits and other defensive assets;
- the safety net of guaranteed income for life;
- income that can be linked to inflation;
- improved tax outcomes – the deductible amount of a non-super lifetime income stream’s regular payment is not assessable for tax purposes; and
- estate planning benefits - for super or non-super lifetime income streams, clients can nominate one or more beneficiaries so that any lump sum payable on death does not form part of the estate.
Five: Annuities allow for ‘set and forget’ spending giving clients the confidence of balancing their budget
When life expectancy is only a guestimate at best, getting the saving versus spending equation right in retirement is a challenge. Retirees can either overspend, assuming that their spending will decrease as they age, or underspend out of fear that their money will run out. Research2 in fact shows that while spending on discretionary items reduces over time in retirement, spending on the everyday essentials broadly remains the same, as costs such as healthcare increase with age.
Even for clients living a modest retirement, the full Age Pension isn’t enough to meet their everyday essentials:
|ASFA’s modest retirement standards*||Maximum Age Pension rate (annual)**||Income deficit|
*Based on ASFA’s June 2020 retirement standards for those around age 65
** Maximum Age Pension rates as at 20 September 2020
One way to solve this problem is by using an income layering strategy in your client’s retirement income portfolio. An income layering strategy combines several sources of income to provide an extra layer of protection in retirement.
Using a lifetime annuity as a part of a layering strategy gives your clients a layer of guaranteed income on top of the Age Pension, and peace of mind that they can confidently spend on what they need without worrying about falling short.
1. National Seniors and Challenger, Outlook for Australian seniors’ retirement plans, August 2015.
2. Spending patterns in retirement
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