Income annuities as an alternative to bonds

{Note from mods: this thread split from here: Exchange Traded Funds (ETFs) 2020 [ETF]}

What are the alternatives to bonds in the allocation? Cash? Precious Metals?

I found this article Bond Alternatives And Alternative Fixed Income Investments although it is retirement focused.

In summary :

1. Real estate, income annuities, and perhaps Whole Life insurance might be your best bet for uncorrelated returns.
2. Retirement planning: Never forget about pensions and social security, which are bond alternative gold.
3. Asset allocation is most important
4. Money in offset to home loan is an excellent alternative
5. Don't chase yield, which only increases risk. The objective should be total shareholder return.
6. When you have won the game, go conservative and assume the victory formation.

 

They might be the single most underrated investment vehicle for retirees given the preferential age pension treatment. Lifetime annuity + pension loan scheme + age pension is a darn good longevity risk nullifier if used properly. Not advice, just an opinion.

Off topic sorry!

Sure is! A great interest rate hedge, and helps me feel comfortable about investing in asset classes like usa mid caps etc. which have higher volatility. Great for a "barbell" strategy.

 

This is very interesting! I was given to understand this style of annuity is still relatively new to Australia...

Is the capital guaranteed (by government or a private company?)

Would love to hear opinion from anyone who has actually used this as part of retirement cash flows.

 

Challenger is one provider and has been around for a bit. However, it is a private provider so you could be relying on it staying in existence. Last time I looked at the numbers you'd get about $45k for plonking in $1M. I think the annuities can be indexed linked but there would likely to be caveats surrounding it (lower commencing annuity, etc.)

Home | Challenger

 

so an average of 4.5% return ..hmm...okay nothing to shout home about but the key here is : will the provider be around say in 30 years ?

That is why i would prefer if the govt be the said provider..if not i would certainly not take the risk!

 

Calculation with $1m, indexed and assumed inflation of 2.5%, 65 yo male, starting annuity is $39,605 pa. Don't know - or care - if it is considered taxable income.

It's called the Age Pension.

 

Haha very funny made my (joke of the ) day !

 

I have not read in details but I know someone the husband retired and took the option, within 2 years of retirement the husband passed away. My very limited understanding is that one will benefit taking this option if one lives to a very old age, else one would forego the capital.

 

I haven't used it as I'm way too young (thankfully), but have looked into it for an elderly friend. The things I really liked about annuities are (quickly modded from what I wrote for her):

1. Lifetime annuities are given very special treatment with respect to the age pension. After 5 years (or it seems from age 84 on - not sure exactly how this threshold kicks in) only 30% of the purchase price counts as an asset. Only 60% of the income you get from it counts as well. If you bought one now (female 82yrs old) for $100,000 you would get around $8,500 per year, indexed to inflation, for the rest of your life. This would have minimal impact on your ability to get the max pension. That’s great peace of mind given the risk in a lot of your other investments (she has some direct shares). Your statistical life expectancy is around 94, with a good chance you will get to over 100yrs old given the longevity of your family members. Factor in that there may be medical breakthroughs that extend your life even further and this seems to me to be a reasonable investment to ensure you always have a pension top-up.

2. You are punished heavily for being over the threshold for maximum pension payments. You lose 50 cents for each dollar above the threshold. By finding the sweet spot for income you can still get the max pension whilst also getting this top up, and still have $238k in the bank because the annuity only counts as a $30,000 asset. Investing this cash for gains doesn't make much sense as you lose 50c in the dollar of your investment income.

3. With your house being worth quite a bit, if you get the pension loan scheme you can top up your "income" even more. Importantly this does NOT count against the income threshold for the pension.

For her, my calcs suggested that she could have an income of nearly $42k per year confidently for the rest of her life whilst allowing her to stay in her home and this is WITHOUT spending her cash. She could very safely spend 20k of her cash to top this up each year to make her income $62k per year for the next 10 years, after which if she is still alive she could then either live on the $42k or sell her house (I doubt she would still be capable of living there but I didn't want to say that) and still have a huge windfall as the pension loan scheme has little impact on her PPOR equity unless it runs for 20+ years and prices don't go up.

Long story short - if she has a house and $338K then using an annuity, pension loan scheme and cash in the bank she could live very, very comfortably in her house for the rest of her expected lifetime, and many years beyond without stressing about shares, interest rates, living too long, losing the house etc. etc.

Annuities only make sense in specific circumstances, which in my research is when used wisely with the age pension. If you have a lot of money/investments they probably don't make sense, but I'd say for a large proportion of the typical retirees they might make sense.

Commonwealth Bank does annuities, I haven't looked into the guarantee on them but would expect it to be pretty good.

NOTE: This is not advice. Just my thoughts. DYOR

 

That's it - if you die young the provider wins, if you live longer than expected you win. Of course it's stacked against you winning as they are not charities BUT when used with the age pension it's heavily stacked in your favour.

 

That is awesome work there @Ross36. Ties in with your effort to assist the dear gal over the financial "adviser."

 

Thanks for the kind words, and yep I did that up for her to take to her financial "planner" to pick holes in. I was hoping that my early morning reading and research would be verified, but funnily enough the "expert" didn't get back to her.... Again - this is just my understanding of how it works, I may well be wrong. If she decides to go this path and gets professional advice I'll provide an update on whether I was right or wrong.

In the grander scheme - and getting the thread back on topic - this does seem like a heck of a safety net for equity investors. If you invest in LIC's/ETF's and just happen to get whacked during the drawdown in retirement knowing methods like this exist could really help. My thinking (without crunching numbers) is that if you had a decent but by no means "won the game" amount (say 800K) and a PPOR at retirement (say 60yrs old) you might benefit from being very aggressive (eg. 100% equities) with a high drawdown rate (eg. 6% for $48k per year). You then check each year to see how much an annuity costs to maximise income without impacting the age pension, and if your portfolio ever hits that value (plus the cash you can have in the bank as an asset without impacting the pension) that's your stop loss. At 67yrs old, single and male it's around $400K. You then switch to the method I described earlier and you get the pension + annuity + pension loan.

That is very "off the top of my head" - so please don't take it as advice!

 

And that old thing called timing plays a part. Knew there was something about it and found it in the 2019 LIC thread when there was discussion on conversion rates for a DB pension. At the time you'd get $44k pa on $1M for a 65 yo male. Now it's down to $39.6k pa.

So another potential risk to consider with annuities.

Posted this just to drag the thread off topic.

Likely won't ever be seen again.

 

For this very reason I'm not a fan plus as stated it's fingers crossed that 'the mob' who issue the annuity stays in business.

 

I don’t like handing my money over to someone and then having to ask for it back. A bit like buying timeshare for accommodation.
Years ago we prepaid video rental ( I think it was $100), then rented the video twice, bad quality video. Never used that afterward. Lesson learnt.

 

That's also one of the reasons I'm now staying single (oops )

 

As the other qualification you mentioned isn't strictly necessary I've fixed it for you.

 

Great, now you tell me

 

But as was mentioned earlier - what's the alternative now for a retiree with a bit of money but not enough to confidently last forever? Bonds are scary to me at the moment, shares are great but we all know how volatile they can be, term deposits and savings rates may well be less than inflation.

To put annuities in perspective - in the example I gave it's a 8.5%pa return from the annuity but with the guarantee you lose your capital. HOWEVER, the 100k she puts in would only count as a 30k asset, and hence she gets a nearly 10%pa income kicker from the age pension asset test. So in essence that's a return of around 18.5%pa on the investment, but you're guaranteed to lose the original amount, and the income stream WHEN YOU DIE. Also, if commbank goes bust your house and shares are probably in the same boat.

So again - it only suits some situations. But I can see now why they say you're nearly as well off retiring at 67 with 400k than 800k. Those pension asset and income tests are very harsh.