How the risks of retirees are managed (2023)

One of the biggest challenges in investing is the transition to retirement. When you step away from your career, you need to make sure you have enough savings for the rest of your life.

After years of building your portfolio, suddenly it's time to sell it to pay for your everyday expenses.

This can be stressful for even the most experienced investors. Are you spending too much or too little? Is your portfolio too aggressive or too conservative? How do short-term movements in the market affect your pension?

Throw in some inflation and an uncertain economic environment, and what should be a break from a life of hard work can be worrying. And yet, there is a way to mitigate much of the retirement risk. A path followed by a surprisingly small number of investors.

What are annuities?

Annuities provide a steady stream of payments to an investor. This flow can be for a certain period of time or for life (annuity payments). These payments can also be linked to the CPI, protecting you from inflation that erodes your purchasing power.

Although annuities can be purchased by anyone, they are especially popular with investors who are retiring.

One of the uncertainties of retirement is how long you'll live, and therefore how much you'll need to save to support yourself. This guaranteed payout, especially with annuities, gives investors peace of mind in retirement as they receive a regular stream of income until their death.

How Annuities Work

According to the AIA (a provider of annuities), the periodic benefits you receive depend on:

• your purchase price
• the length of your annuity
• the residual capital value (RCV) you choose (if applicable)
• the prices we offer at the time of investing and
• whether you invest with your own savings or with money from your supermarket.

As an indication, Challenger offers the following rates for a female investor, per $100,000 invested:

One of the most frequently asked questions about annuities is: what happens to the principal after you die?

The purpose of an annuity is to hand over your principal to receive a guaranteed income. If you die early (determined by the age at which you receive your annuity), a death benefit will be paid to your beneficiaries. In some cases, the death benefit is a full refund of the original premium, so in addition to guaranteed income, some investors consider it insurance against early death.

An example of this is a 75-year-old pensioner. He will get his principal back if he dies within 10 years, in addition to the interest he has already received. Then there would be a reduced death benefit based on life expectancy.

How Annuities Fit Into Investor Portfolios

As an asset class, annuities would be included in fixed income.

Unlike stocks, annuities are not affected by stock market movements, although there are some products that you can link to stock market movements.

Unlike most forms of fixed income, they are not affected by interest rates. This means that retirees don't have to worry about things like inheritance risk and longevity risk, two of the biggest concerns in retirement.

Annuities are not intended to replace all of your income after retirement. They are intended to be part of your retirement strategy that provides a guaranteed basic income while allowing other assets to take the risk to increase returns. There are also allowances for being the holder of a life annuity and receiving the retirement pension.

For annuities beginning on or after July 1, 2019, the rules generally assess:

• 60% of the purchase price from the income stream for life up to age 84, with a minimum of 5 years. AND
• After that, 30% of the purchase price.

You can invest in life annuities through supermarkets or as a personal investment. If you go through your super, regular allowances apply, such as a tax-free old-age provision.

It is also important to consider that annuities are relatively illiquid.

Unlike other instruments, you cannot partially sell investments. If your circumstances change and you need to access your investment, you can withdraw 100% of your lump sum up to a certain holding period, after which it will intermittently reduce to 0%. Once the withdrawal period has expired, you will no longer have access to your principal and will continue to receive your guaranteed income for the rest of your life. An example of this is shown below:

Source: Challenger, Annuity for a 65-year-old woman

An important consideration with annuities is whether investors want to leave a legacy to their beneficiaries.

After the withdrawal period, there is no option for you to withdraw your money and the principal will be paid in exchange for a guaranteed income. This means that you will not have any money left over for the annuity portion of your portfolio to go to your beneficiaries when you die.

if you have a partner

If you have a partner, you can keep your investment together if it is super invested outside of it. This means that you can split the income for tax purposes.

If one of the annuity owners dies, the surviving owner can continue to receive the money as a stream of income (with a reduced interest rate) or as a lump sum.

What happens if my annuity provider goes bankrupt?

The issuance of annuities is supervised by the Australian Prudential Regulation Authority (APRA). They make sure the annuity issuer has enough money to make all the payments to pay off the annuity.

This is stronger than the requirements for corporate bondholders. More than likely, the annuity issuer has more than enough capital to pay you back. If something happens to the company, your annuity payments must be made before bondholders or stockholders are paid.

Graham Hand, Editor-in-Chief of Firstlinks, shared his thoughts on annuity retention, including concerns about annuity providers' underlying investments.

"A 'term annuity' from a life company is not like a 'term deposit' from a bank. The annuity is only as strong as the underlying issuer and the assets it owns. For example, to pay 5% to the ​investor, you to cover the cost of capital and profits, the life business will need to invest about 7-8% To achieve this return, assets typically include real estate, sub-investment grade investments, and perhaps private assets that They may be experiencing an economic downturn.

Bank deposits are not only covered by the bank, but also by a government guarantee of up to $250,000. Personally, I wouldn't want a large exposure to an annuity issuer for the rest of my life because I don't know how the underlying assets will perform in the next 20 to 30 years,” he says.

Why are more Australians without an annuity?

There are many annuity providers in Australia, but there is not much interest in most annuities purchased for clients through financial advisors.

The Australian Association of Actuaries cited a study by their US counterparts into why investors are not buying annuities of the expected size.

The most common answers were loss of liquidity, loss of assets due to death, low risk aversion, so retirees are willing to take more risks to obtain profits and greater personal consumption. Investors prefer to consume more of their capital when they are young and fit, traveling and enjoying life, and don't value a steady stream of income that pays them the same for decades. They want the flexibility to withdraw and use the amount that works best for them.

As part of an overall portfolio, annuities can help investors with this.

Another interesting answer was that investors already have a guaranteed income through the old age pension, so they don't need two sources of guaranteed income. They would rather watch retirement kick in and put the money to work in a riskier asset class. This is a perfectly legitimate reason for past annuities.

Investors who have already met their fixed income and cash income criteria may find that annuities put less risk on their portfolio than is necessary to maintain their lifestyle.