Nick Bruining: Annuities now part of a retirement planner’s toolkit

Thanks to historically low interest rates over the past decade, annuities fell out of favour with financial planners and their clients. Thanks to higher rates however, that’s now changed. Combining safety with generous investment returns and significant Centrelink concessions, annuities are now very much a part of the retirement planner’s toolkit. An annuity is a form of retirement income stream where the investor exchanges a lump sum amount for a guaranteed income stream, paid for a specified period of time. That period could just be for a few years or the rest of your life — no matter how long you live. Add-on features include annual indexation of the payment rate, either at a fixed amount or to the consumer price index, a guaranteed payment period during which payments continue even if you die, reversionary ownership with a partner, which means they would continue to receive all or a portion of your payment, and finally, you can opt to have limited access to lump-sum amounts along the way. All of these options add to the risk of the annuity provider paying out for a longer period of time. Similarly, the possibility of making lump sum payments needs to be factored in and the only way to allow for these risks is to reduce the contracted payment amount from the start. That means removing or adding on features will usually change the regular payment amount you receive. Generally speaking, payments from a lifetime annuity cease once the investor dies. No amount is returned to the estate, unless you decide to add on that feature. While annuities are relatively inflexible once they start, the safety of the investment and the certainty of future payments makes them highly attractive. There’s no small print in the paperwork that says you risk losing all or some of your capital, but equally, there’s no government back-up like the financial claims scheme that protects depositors in banks, building societies and credit unions. Instead, annuity investors rely on the very strict government controls imposed on providers. Providers are directly supervised by the Australian Prudential Regulation Authority. This is the same authority that supervises the banking sector. APRA’s role is to continuously ensure an annuity provider has sufficient capital and reserves to meet the payment obligations of the fund now and into the future. Under that regime, no annuity provider has ever gone bust. Also as a result of these very tough conditions, there are only two mainstream lifetime annuity providers in Australia: Challenger Life and Resolution Life. Where a superannuation fund offers a lifetime annuity, it is usually a “badged version” from one of these two providers. Recent annuity customers have benefited handsomely from the interest rate rises of the past two years. For example, a 67-year-old man beginning a no-frills lifetime annuity with Challenger with $100,000 to invest last week could expect to receive a starting payment of $496.83 a month, or $5961.96 a year. Importantly, this figure is indexed to the CPI. If the inflation rate for the next 12 months returned to 7 per cent for example, the annual payment next year would rise to $6379.30. The payments and the indexation to CPI continue until the person dies. If you included options to access some of the capital along the way or a partial lump sum payable at death, the annual amount from the start would reduce by about $450 a year. A 67-year-old woman investing the same amount in a no-frills Challenger product could expect a starting monthly payment of $460.79, equating to an annual payment of $55,529.48 a year, reflecting the fact that statistically, women live longer than men. While the lack of flexibility associated with a lifetime annuity is an issue, most financial planners use them in conjunction with conventional income stream investments such as account-based pensions. That way, you get the safety and security of an annuity coupled with the unrestricted access to capital, available through an ABP. Nick Bruining is an independent financial adviser and a member of the Certified Independent Financial Advisers Association