I was scanning the financial news the other day and noticed that one of Australia’s biggest annuity providores had reported a record profit for the 2015/16 financial year. Their sales of annuities had increased by a whopping 22% on the previous year; certainly no easy feat with interest rates con- tinuing to head south. It certainly indicated to me that retirees are not taking any chances with their money, and were trading off possible return for security.
Now this might not be such a good thing in my opinion. Security of capital is certainly an important consideration, but locking up your funds in exchange, is not what I would consider a fair swap. An- nuities need to be considered as a portion of your investable funds rather than the main instrument of income production. Remember in earlier posts I talked about timing the market, well if interest rates are at their historical low, this is not the time to invest long term in a product that provides its earnings from prevailing rates – got me!
But any way, lets take a bit of a look at the humble annuity.
Originally, annuities were designed to act as a reliable means of securing a steady cash flow for an individual throughout their retirement years. Additionally they have the added benefit of alleviating
fears of longevity risk – the risk of outliving one’s as- sets as the funds can be invested for a person’s lifetime. Anyone who is highly risk adverse and would like the security of knowing they will receive income no matter what the economic climate is an annuity candidate.
They run for a fixed amount of time, from a one year duration right up to a lifetime, and everything in between. The income can be paid monthly, half yearly or yearly whichever is preferred and continues until a preset maturity date.
The rate of return is fixed at the purchase date, but inflation increases and incremental drawdown of capital can be built in at establishment. Often these capital drawdowns are used to improve the monthly cash flow, but obviously taking this option will erode, or depending on the amount chosen, completely deplete the investors capital.
On the negative side, once your funds are committed there is no getting them out. (There may be some exceptions so check first) Your money is locked away in return for the income payments. Need a new car; sorry you won’t be getting any money out until maturity!
A real negative is that annuities are designed as long term retirement products and their rate of re- turn is calculated on current prevailing interest rates and then fixed till maturity. Currently, we are in the lowest interest rate environment in 40 years, which is not a very good time to lock in for your lifetime.
Also the estate planning side of annuities also needs to be fully understood prior to purchasing one. An annuity is not always structured to provide residual benefits into an estate, and it is extremely important, prior to making a commitment, to clearly establish with your advisor the estate planning ramifications.
But remember, before doing anything, always discuss your needs with a licensed financial adviser. It is their job to ensure that the positives of annuities clearly outweigh any negatives before proceeding.
For me, I am not greatly enamoured with annuities, long term investments that provide a fixed in- terest rate created at the historically lowest point is not really screaming out ‘good value’ !
