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Wednesday, 24 March 2021

Looking into purchasing a deferred lifetime annuity to compliment superannuation account-based pension

I'm fortunate that both my parents are still alive (aged 89 and 85) and reasonably healthy, I also have one great-grand Aunt who is still alive at age 105 (but suffering dementia in recent years), and my paternal grandparents both lived to 94 years of age. So, although the life expectancy of an Australian male my age is currently 85.56, there is a reasonable chance I could still be around in my nineties (especially if I lose my excess weight and exercise more), or possibly even make it to 100. There might even be some novel medical treatments that become available during the next four decades that extend healthy lifespan more than the 0.2% annual increase that occurred in recent years (2018-2020).

Therefore, although I'm currently on track to reach the superannuation transfer balance cap by the time I 'retire' (transition from my current full-time employment to working part-time as a financial planner), which should provide sufficient retirement income to maintain my present lifestyle indefinitely, there is always 'longevity risk' that I may exhaust my retirement savings before I die, especially if sequencing risk has an adverse impact (a few 'bad' years at the start of your retirement have a much greater impact that similar 'bad' years occurring towards the end of your draw-down period, even if the average ROI is identical).

One can however 'insure' against longevity risk by purchasing a lifetime annuity, that will provide a fixed income stream until your death. Of course the net amounts expected to be paid out have to match the premiums paid in, plus investment returns, minus the providers costs and a profit margin. Therefore, purchasing an immediate annuity (that starts making payments straight away) provides quite a low ROI (around 4% pa, which is quite poor considering part of that is simply the return of your principal). But it is also possible to purchase a deferred annuity using superannuation money (once you reach retirement) that doesn't start to provide an income stream (hence is 'deferred') for a chosen number of years.

If the deferral period is quite low (so you are almost certain to receive income for a number of years) or the annuity has a 'death benefit' (life insurance component), or can be withdrawn early (get your money back), or will continue to make payments to a surviving spouse, then the income stream is also reasonably modest. However, if you choose the option to have no death benefit, no option to withdraw, and no reversionary beneficiary, then the amount of income you may receive (especially if it is deferred beyond the average life expectancy period) can be quite high.

For example, at age 60 I could purchase (if I was retired) a $10,000 deferred annuity with a 35 year deferral period (i.e. start paying out at age 95) and no death benefit, withdrawal option, or surviving spouse benefit that would pay $8,225 pa indefinitely. Similarly if I retire at age 65 I could then purchase a $10,000 deferred annuity with 30 year deferral period (still commencing payments only if I live to 95) of about $8,775 pa. So, as long as I don't receive any income unless I live past 95, it makes little difference whether I purchase the deferred annuity now, or in 5 years time.

So, although there is a risk that you might die too soon to receive ANY payment from a deferred annuity (if it doesn't have a death benefit), it does provide a mechanism to ensure you have a reliable income stream in the event that you live a lot longer than you expect.

For example, if I rollover $100K of my TBC into a deferred annuity that doesn't start paying until I reach 95, I would then receive about $85,000 of tax free income from the annuity each year until I die. If I happen to live as long as my great-grand Aunt the total return could be up to $850K on a $100K 'investment'. The annuity payments are increased in line with inflation (cpi), so those figures are all in current $ terms. This isn't quite as much as you *might* end up with by simply leaving the $100K in retirement-phase superannuation *if* you achieved a consistent average 5-6% real ROI, but the difference is basically the cost of insuring against sequencing risk.

Of course if I die before reaching 95 then my $100K will have gone towards funding the income streams of other annuants that live long enough to collect. But I won't be around to be upset by this!

Overall, using $100K (about 6%) of my $1.7m or $1.8m TBC to purchase a deferred annuity looks quite a good option to ensure I have a guaranteed (as long as the insurance company stays in business) income stream if I live to 95+, especially if investment returns during the next 40 years are worse than average.

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3 comments:

Financial Independence said...

There is great hope for you to enjoy your nest egg for 30-40 years, once you are going to retire!

I dont quite understand the reason to purchase $10,000 deffered annuity with a 30 year defferal period at $8,775 per annum.
Is $10,000 a month? I am also wondering who will look after your financial interests at the age of 95, if some troubles will come?

For me its a bit of a gamble, considering if the company will be still arounnd after 30-40 years. Most of S&P500 companies dont last that long.

enoughwealth@yahoo.com said...

I think the life insurance companies in Australia are pretty well regulated, and only one company (Challenger) offers deferred lifetime annuities in Australia. I think that if the insurance company ran into financial trouble to Australian government would bail them out (eg. inject some money and take a part ownership) as the security of the retirement income system is one of their top priorities.

If I was between 60 and 65 years old and retired (you can only purchase a deferred annuity using superannuation money once you have reached preservation age (59) and satisfy a condition of release (eg retire)) I could purchase a deferred lifetime annuity for $10,000 using money rolled over from my superannuation account. If I chose a deferred annuity that didn't have any death benefit (if I die before the payments are due to start I get nothing), and doesn't provide any reversionary benefit (when I die my spouse wouldn't continue to receive any payments), and it didn't start making payments until I reached 95 years old, I would get a payment of around $8,775 pa (indexed to the cpi). That payment would then continue each year until I died.

The exact amount of payment is quoted at the time you purchase the annuity. And then increase with the cpi index if you choose the 'fully indexed' option.

The annuity payments would be a lot lower if you choose to have a death benefit (ie. a sum would be paid out if you died before reaching the annuity payment start date), or if you had opted for a reversionary payment to a surviving spouse (eg. my wife would continue to receive payments after my death).

In my case I might buy a $100,000 deferred annuity, so I could draw down on my account based pension once I put my super into 'retirement phase' and would only need the money to last until 95, as I could be pretty confident that I'd receive the equivalent of $87,775 in today's money (as it is cpi indexed). If I died before reaching 95 the annuity would never pay anything out, but I wouldn't need that income anyhow ;) As I will only need around $65,000 pa tax-free superannuation pension payment to completely replace my current salary income, I would probably only need to buy an $80,000 annuity - I find out the exact figure when I reach the required age and retire, so I can get a quote.

If I purchased a deferred annuity for $10,000 that only have a deferral period of 10 years (for example I purchase one when I retire at 65 that would start making annual payments when I hit 75), there would be a much higher probability that I'd live long enough to start receiving some payments, and the payments would likely continue for a much longer period. Hence the annual payments would be MUCH lower - only $628 pa. So I may as well just leave the $10,000 in my normal superannuation account.

enoughwealth@yahoo.com said...

Just to be clear, you purchase the deferred annuity with a one-off payment, and (if you live long enough) you get an on-going monthly payment starting at the deferral age and continuing until you die.

So, I could make a one-off payment of $100,000 today (if I was 60 and retired) to purchase a deferred annuity with no death benefit, not reversionary (spouse) benefit, and a 35 year deferral period (ie. it wouldn't start making any payments until I turned 95), and the annuity payment amount would be $6,614.18 ($79,370.16 in today's money) from age 95.

BTW the quote I just ran came back with a slightly lower annuity payment that I got last week, which shows how the quoted annuity payment will change as the prospects for inflation, long term investment performance, and life expectancy changes over time...