Historically, Australian retirees have not been large users of annuities, but this isn’t a sign that people don’t want an income that is guaranteed for life. In fact, surveys of what retirees want, but that don’t mention annuities by name, repeatedly find that income for life is strongly preferred.
Sixty-seven per cent of respondents in a recent survey of over 3000 super fund members thought that such a product feature would be appealing for their super.
The problem might be less about the appeal of the annuity itself and more to do with some common misunderstandings. But continued product innovation means that at least some of these fears can be relegated to history.
This article considers the most common myths about annuities and highlights the reality for retirees who want guaranteed income in retirement.
Myth one: ‘I will lose everything if I die early’
Wrong. Annuities can pay (your estate) if you die early.
Challenger has addressed this concern by offering a ‘death benefit’, which provides a potential full refund of the initial premium in case of early death with many lifetime annuities. The death benefit provides insurance against the risk of early death.
Some policies have included a minimum payment period (of say 10 or 20 years) with a refund of the initial investment providing additional peace of mind. Now, instead of the risk of losing everything, early death means that your estate can receive all of the initial capital*. This can be a very attractive feature, given that this is on top of all the payments made to you while you were alive.
For a typical retiree at age 67, the maximum death benefit will last nine to 10 years. Beyond that, a smaller death benefit is payable on a reducing basis to life expectancy. A death benefit means that you and your family don’t lose if you die early, and it is now a standard feature of most lifetime annuities sold in Australia.
Myth two: ‘Returns from annuities are always low’
Wrong. You can maintain share market exposure with a lifetime annuity.
Historically, lifetime annuities have typically been designed to behave like fixed-rate securities. Therefore, the expected return on these investments is lower than the expected return on share markets over the long run because they are a lot less risky, plus the annuity payments are payable for life. However, recent changes to superannuation rules allow a lifetime income stream to include exposure to equity markets.
In these circumstances, the payments will be subject to fluctuations up or down but will, importantly, continue for life.
Recently, Challenger launched a Market-Linked Annuity that will make payments in line with one of five underlying diversified indices in the same way that a non-guaranteed, market-based income stream would rise (or fall). The Market-Linked Annuity will make payments for as long as you live. The payments are based on the underlying market returns from year to year, not just what can be guaranteed at the time of purchase. Therefore, this annuity may be suitable for you if you want your payments linked to investment markets to have the potential to grow your income over time, while accepting some downside risk.
Myth three: ‘I would have to put all my savings into an annuity’
Wrong. Annuities are not an all-or-nothing solution. They are designed to complement other retirement investments and sources of income, such as a pension from your super and the Age Pension.
Under certain conditions, such as retirees with no need to leave an inheritance to their estate, it could be economically rational for a retiree to annuitise all their wealth to maximise their income for life.
However, it doesn’t mean that you need to annuitise everything. A traditional lifetime annuity pays an income stream that is guaranteed for life, sometimes with an in-built inflation adjustment.
But spending patterns in retirement can fluctuate depending on the retirement stage. Spending is often higher in the earlier, active phase of retirement, and large expenditures can be lumpy. Most retirees don’t take an overseas trip every year. There is a range of other spending that might be desirable but isn’t essential.
In a pinch, this spending can be delayed or forgone if required. Such discretionary spending can be adjusted. Essential spending, on the other hand, happens every year.
It is also worth considering the Age Pension in Australia as a safety net; it means that you don’t need to put aside as much for essentials in a worst-case scenario.
This means a sensible retirement plan can have the best of both worlds. By investing part of your savings in an annuity’s lifetime income stream, you can ensure that you will have all the income you need for as long as you live. You can maintain the majority of your savings in more flexible investments so you can spend it when you are best able to enjoy the benefits.
Myth four: ‘Everything is invested in one place, increasing the risk’
Wrong. Annuity payments in Australia are protected by prudential supervision.
Life companies that issue annuities and institutional group annuities are supervised by the Australian Prudential Regulation Authority (APRA), which requires them to hold sufficient capital today to be able to make all payments to the annuity holder in the future. This elevates the strength of the promise to an annuitant significantly.
APRA requires annuity providers hold enough capital to meet a one in 200-year adverse market event. While markets can go awry, APRA actively monitors life company investments with the aim of ensuring that the life company can meet the promises it has made to its customers both now and into the future.
Challenger, like most life companies, holds significantly more capital than the regulatory minimum providing even greater security for annuity holders.
Myth five: ‘My high return investments mean I’ll never run out of income’
Potentially wrong. Annuity payments are made up of more than just income.
The term ‘retirement income’ creates some confusion primarily due to the word ‘income’. Annuity payments are retirement income but are more than just ‘income’ from investments. Annuity payments also include partial returns of capital.
In general, spending very little is a way to ensure that the money lasts but that doesn’t maximise your retirement income and can reduce your quality of life. To do this, you need to spend some of the capital. With any investment that is not annuitised, like an account-based pension, spending the capital creates the risk of the money running out.
Why choose an annuity?
Retirement is a life-changing event. As you adjust to your new lifestyle, you’ll need to think differently about your finances. Moving from earning an income to drawing on your retirement savings and investments can be a big shift mentally. And it can bring up financial concerns you haven’t thought too much about before, such as:
- the risk of outliving your retirement savings and becoming completely reliant on the Age Pension
- the impact of market conditions on the value of your investments during your retirement
- the risk that over time inflation will increase the cost of living. This means the income received from your investments may also need to increase in line with inflation to maintain your standard of living.
Annuities can help to address these concerns so you can relax and enjoy your retirement.
We’re here to support you. For more information about Challenger’s lifetime annuities, read the PDS and TMD, or talk to your financial adviser about whether this is an option for you. Alternatively, visit challenger.com.au or call us on 13 35 66.
Challenger is a preferred partner of YourLifeChoices.
Disclaimer: The information in this document is current as at 1 June 2022 unless otherwise specified and is provided by Challenger Life Company Limited ABN 44 072 486 938, AFSL 234670 (Challenger, our, we, us), the issuer of Challenger Guaranteed Annuity (Liquid Lifetime) also known as Challenger Lifetime Annuity (Liquid Lifetime). The information in this document is general information only about our financial products. It is not intended to constitute financial product advice. Investors should consider the Target Market Determination (TMD) and Product Disclosure Statement (PDS) and the Statement of Advice prepared by their financial adviser before making an investment decision. This information has been prepared without taking into account any person’s objectives, financial situation or needs. Each person should, therefore, consider its appropriateness having regard to these matters and the information in the TMD and PDS for the product before deciding whether to acquire or continue to hold the product. A copy of the TMD and PDS is available at challenger.com.au or by contacting our Investor Services Team on 13 35 66. For Liquid Lifetime (Market-linked payments) option, only the first year’s monthly income amount is guaranteed. After the first year, monthly payments will move up or down annually adjusting to the changes in your chosen market-linked indexation payment options. In periods of strong market performance, any Age Pension benefits may reduce to reflect the higher income received.
Challenger Life is not an authorised deposit-taking institution for the purpose of the Banking Act 1959 (Cth), and its obligations do not represent deposits or liabilities of an authorised deposit-taking institution in the Challenger Group (Challenger ADI) and no Challenger ADI provides a guarantee or otherwise provides assurance in respect of the obligations of Challenger Life. Accordingly, unless specified otherwise, the performance, the repayment of capital and any particular rate of return on your investments are not guaranteed by any Challenger ADI.
* The maximum amount that could be received by your estate or beneficiaries depends on the time which has passed since you invested in the annuity up to the date of your death.
