With the cash rate moving higher and some online savings accounts edging towards 5%, retirees who rely on steady income are suddenly in a stronger position than a few years ago. Term deposits are an obvious option but they only run for a fixed period and then need to be reset at whatever rate is on offer at maturity. That is why more investors are starting to look at lifetime annuities, which turn a lump sum into guaranteed payments for as long as they live and are backed by providers that must follow strict prudential rules set by regulators.
Under a typical lifetime annuity you hand over, say, $100,000 and receive a regular stream of income that usually adjusts with inflation, with the provider investing mostly in defensive assets such as fixed income and a modest allocation to shares and property. For example, a 65 year old putting $100,000 into an inflation linked lifetime annuity might currently receive just under $500 a month, adding up to close to $150,000 over 20 years, which works out to around a 4% annualised return if they live to their statistical life expectancy in their mid 80s. Living five years longer could lift the effective return to above 5% and stretching ten years beyond average life expectancy can push that closer to 6% a year, although anyone who dies earlier effectively subsidises those longer lived investors.
To soften that trade off, many providers now build in capital protection and some liquidity features, particularly for people starting annuities around retirement age. A retiree who dies in the early years of an annuity may have up to 100% of their original investment paid back to their estate for a defined period, which can extend for a decade or more before tapering down. Some products also let investors cancel and receive a reduced lump sum, for instance after 12 months a 65 year old might be able to recover around $95,000 of a $100,000 annuity, with the available surrender value gradually stepping down over time while they keep any income already paid.
There is, however, a structural cost to this peace of mind. Annuity providers are commercial businesses, so they keep a slice of the investment return to cover profit, overheads and the extra reserves needed to pay those who outlive expectations. A retiree could, in theory, build a "DIY annuity" by investing around three quarters of their money in bonds, with the rest in shares, property and a small portion in other assets, and then drawing roughly 5% a year. That approach might leave more for beneficiaries if markets perform well but it also means personally carrying the risk of market downturns or bond defaults.
Lifetime annuities also interact in a useful way with the age pension for some people. For Centrelink purposes, only part of the amount invested in a lifetime annuity is counted under the assets test, 60% up to age 85 and 30% thereafter, while just 60% of the income is assessed under the income test at any age. In practice this treatment can help retirees sitting near the thresholds to improve or preserve their pension entitlements even as they lock in guaranteed income from an annuity. With interest rates rising, the balance between flexibility, risk transfer and potential pension benefits makes lifetime annuities look like a tool worth considering as part of a broader retirement strategy rather than a one size fits all solution.
