How to create a safe income in retirement?
Working with retirees over the years, one thing that I have learned is that it is not the highest rate of return that counts, but security of income that will be delivered, no matter the state of economy, no matter what the market is doing, no matter any other financial impacts or disasters.
Retirees want to feel safe that every morning when they walk up, their income will be delivered, no matter what.
If you are one of those retirees, this article will provide you with information, that is essential when building your retirement income stream.
Today we will be talking about creating the most predictable, safe, and reliable income for the rest of your life.
This is the question I receive at almost at every new meeting:
How do I organise my money, so I can be assured that I will have income provided to me for my life, for life of my spouse, if you have one, and it will not be impacted by market fluctuation and volatility, but rather be secure and reliable.
The answer to this question are annuities. Why?
Why would I say that annuities are the way to structure income in retirement?
I spoke about annuities on many occasions, you can read the following articles that will explain explain annuities to you such as: “Annuities and your Retirement”, “Lifetime Annuities and Aged Care Annuities”, “Account Based Pension and Annuity – which one is better”.
But each time I get a new question from a client, it appears that there is always more to explain and more to fully understand benefits of this little income stream gem.
1. Annuities are a perfect way to hedge your investment portfolio against market volatility.
2. Annuities are a secure, pre-calculated income stream that does not rely on the market returns to provide you income for your life
3. Annuities can be set up for the investment term of your choice
4. Annuities can continue for the life of your spouse if you set it up with the reversionary beneficiary.
5. Annuities can assist with maximising your Age Pension benefit
6. Annuities can assist in increasing the value of your estate
Let’s go over those listed points one by one.
1. Annuities are a perfect way to hedge your investment portfolio against market volatility.
Annuities are just about the only true guaranteed investment in Australia. As much as I love investing into growth assets, as this is the only way to grow your nest egg over-time. In retirement however you have to find the balance, or a sweet spot between growth and security, therefore you should not have all your money in growth assets alone. Remember GFC? Remember Covid? After the Global Financial Crisis in 2007 it took some assets longer than 10 years to return to the pre-GFC values, you really don’t want for this to happen to your savings during retirement.
Covid was different as the market rebalanced really fast, but as I explained in my articles then, Covid was a medical pandemic, not a financial crisis, hence fast market recovery.
Annuities stayed unaffected over those disasters, paying the agreed level of income to annuitants, so the income stayed unchanged, and this is the reason why we can see annuities as a form of reducing financial risk with our savings.
2. Annuities are a secure, pre-calculated income stream that does not rely on the market returns to provide you income for your life
When applying for an annuity, you will first receive a quote what your income will look like year after year for as long as you are alive. So there are no surprises, you can organise your budget accordingly with the level of income you receive.
3. Annuities can be set up for the investment term of your choice
Annuities can virtually be set up for a chosen investment time-frame, however if one of your goals is maximising Age Pension payments, then we are talking about the life-time annuities.
4. Annuities can continue for the life of your spouse.
The trick with annuities to get the best benefit is to know how much to invest into this income stream to gain the highest benefit, but also to leave sufficient balance outside of the annuity for other reasons. The other trick is to know if it is better to start an annuity on your name or your spouse name, as terms might be different, mainly due to different life expectancy between you two.
You can also commence an annuity with a reversionary beneficiary, meaning that the annuity payments will not only continue for the duration of your life, but for the duration of your spouses live, and that is a great deal of income security.
5. Annuities can assist with maximising your Age Pension benefit
Because lifetime annuities are partially income and assets exempt under the Centrelink means testing, they can assist with improving the level of Age Pension you are receiving, or can assist those retirees with assets just over the limit to become eligible for some Age Pension benefit plus the very special Pensioner Concession Card.
6. Annuities can assist in increasing the value of your estate
This is the point that surprises everyone. Most people think that annuities decrease the value of the estate, while often the opposite is true, when running a comparison between the income stream coming from account based pension alone, as opposed to a combination of account based pension and annuity.
So let’s do a bit of an exercise with a retirement portfolio illustrator:
Let’s meet George and Margaret. They are a retire couple, homeowners. George is 70 and Margaret 67.
They have the following assets:
- $500,000 each in Account Based Pensions
- $20,000 in everyday cash account
- $30,000 in Term Deposit
- $30,000 of value of home contents and car
A total estate value is $1,080,000 and they want to be provided with an annual income of $80,000 to cover their living expenses as well as travel expenses within Australia and overseas.
I see many clients very similar to George and Margaret, so this is not an unusual circumstance.
So let’s now view the outcome of the calculator to see if the above listed points are really true.
In this exercise, we are comparing the outcome of two scenarios:
Scenario 1
All savings continue to be invested into account based pensions and invested as per 50/50 asset allocation – meaning 50% in growth assets and 50% in defensive, income driven assets.
Scenario 2
Each partner will invest $200,000 into a lifetime annuity with the balance of $300,000 remaining invested in the account based pension.
Knowing ASFA findings a couple requires an income of $47,950 plus annual CPI, to cover the “necessary needs” to live a modest lifestyle.
In options 1 George and Margaret are able to meet those income needs 53% of times, while in Option 2 having annuities in place 100% of times. So as you can see, annuity has increased the probability factor of reaching the must to receive income for just a modest lifestyle.
Since they wish to have an income of $80,000, that level of income can only be achieved 47% of times with account based pensions only, while with annuities in place, the probability factor increases to 81%.
Therefore, you can see how annuities are increasing security of the income you want to have in retirement for your life.
The analysis is based on 2000 market scenarios over 40 years investment period provided by Moody’s Analytics.
So why this analysis is important?
- The graph is showing you that George had 75% chance to live another 12 years, 50% chance to live 18 years and 25% to live 23 years.
- Margaret has 75% chance to live 18 years, 50% chance to live 23 years and 25% to live 28years.
- But if we look at them as a couple, meaning at least one person is still alive, they have 75% chance to live 21 years, 50% chance to live 25 years and 25% to live 29 years. That is a very long retirement to plan for and to be provided with income.
So why their income is so much more secure, predictable and greater with annuities then with account-based pension alone?
1. Lifetime income for as long as you live in addition to any Age Pension you may receive. The lifetime income amount in the first year is $22,999
2. An Age Pension increase in year 1 of $5,161 (a big increase over the non-lifetime portfolio).
3. A 100% chance of meeting income ‘needs’ (an increase of 47% over the non-lifetime portfolio).
4. A 81% chance of meeting desired ‘needs and wants’ (an increase of 34% over the non-lifetime portfolio).
5. Total retirement income paid over 26 years increased by $55,583 (in today’s dollars).
6. The Estate value at the end of 26 years increased by $200,388 (in today’s dollars).
Just looking at Age Pension income received between the two scenarios, scenario 1 has a lot of catching up to do. With annuities, they are immediately eligible for the Age Pension in year 1 and don’t forget about the Pensioner Concession Card – big savings in addition to your new income from the government.
In option 1 however, they could become eligible in year 3, so you have already missed out on great deal of income within the first 2 years and every single year that follows, the Age Pension is significantly lower than under the option 2.
Those are only some of the findings that prove that sometimes having a defensive income stream can be very positive to your overall financial outcome for your retirement, not just in year 1 to get some money from the government, but actually have a mixture of different income streams that supplement each other in every financial aspect.
The trick however is to know where is your “sweet spot” – meaning:
- How much to invest
- On whose name
- Which company to invest in
- How to structure the overall supplementary investment portfolio
And that I cannot explain, as it differs for every client that I see and I run this analysis for.
So if today you see something you have not seen before, and something that sparked your interest, please visit my website AboutRetirement.com.au to book a meeting to see how you are set financially for your retirement.
By: Katherine Isbrandt CFP®
Money Strategist & Retirement Planner
Principal of About Retirement
