Structuring a Secure Retirement Income
Chris Forrest- Senior Partner and Principal Adviser, Sovereign Wealth Partners
In our last article we asked the question: can a retirement income be secured? We outlined how prospective and current retirees can best prepare themselves, current solutions and the new world of retirement income solutions coming to market.
New solutions are coming to market as a result of the government’s Retirement Income Review which recommended that retirement product providers provide lifetime solutions.
This article specifically discusses those solutions currently available and how they might be used. We expect the market for such solutions will grow substantially, so it is worth checking at the time you are assessing your options.
This article does not cover account-based pensions and annuities with which many are already familiar. This article does not seek to promote or recommend any specific solution.
As a general comment, if any of the solutions below are appropriate, it is more likely that they are used in conjunction with an account-based pension to provide a tailored, flexible retirement strategy. Personal advice should be sought for your individual circumstances.
It should also be observed that these strategies are designed to provide outcomes which have a high degree of reliability when used appropriately. They are not designed to chase the highest possible returns. They are tools targeting stated outcomes to reduce investor worry.
Solution 1 – Allianz Retire+ FutureSafe
This type of solution is currently unique to Allianz although the concept is not new. Losses in very poor years are limited through a form of insurance. The insurance premium is paid for by limiting the gains in very good years.
Who is it for?
Anyone who seeks market growth while limiting potential losses in poor years. Typically, we would suggest it most suits retirees and anyone self-funded from investments. It may suit investors who are more content with an adequate outcome to meet their needs rather than chasing higher returns.
How does it work?
An investment in this product can be purchased with super or non-super funds. You can choose between a term of 7 years or 10 years. (The 10 year term offers slightly better rates).
This solution is designed to give investors a degree of certainty within a known range of outcomes illustrated in the chart below.
You can select the maximum you are prepared to lose over 12 months if markets turn negative and based on this selection, the provider quotes the maximum you can gain if markets are strongly positive. For example a pricing structure quoted might be a maximum downside of 10% and maximum upside of 10% (or a floor of 90% and a ceiling of 110% of funds invested). This is measured against one of the available benchmarks such as the S&P/ASX200 (i.e. the performance of the top 200 stocks on the Australian Stock Exchange).
Using this example, if the market falls by 5%, then your investment will be market down by 5%. Conversely, if it rises by 5%, your investment will be marked up by 5% which you may choose to take as income.
If the market falls by more than 10%, your investment will be marked down by 10%. Conversely, if the market rises by more than 10%, your investment will be marked up by 10%.
Other floor and ceiling combinations are available and are quoted at the time the investment is made.
You can reset the floor and ceiling each year for the forthcoming 12 months.
The options are illustrated below:
Source: Allianz Retire+
What does it cost?
The cost of this product is 0.8%pa charged annually on the anniversary of the investment.
Pros
Certainty over the range of returns you might expect to earn.
Income can be paid annually or reinvested. You can change your preference year to year.
Downside protection in the event of large negative markets.
The choice to reset your terms annually.
Cons
Locking funds up for 7 or 10 years with limited ability to withdraw capital.
The caps may be low compared to actual market performance.
If linked to the Australian stock exchange, there is no benefit from franking credits.
Reinvested income is locked in for the balance of the term.
Solution 2 – Magellan FuturePay
This solution is unique to Magellan at this stage however it could be replicated by other investment managers. The premise of this product is that in a world of low interest rates, self-funded investors and retirees need increased certainty of income from their share investments..
Who is it for?
Retirees and self-funded investors. It is designed to mitigate ‘sequencing risk’ i.e. the risk of a significant fall in your investment soon after you invest leading to either less income or selling assets at a low price to meet income needs.
How does it work?
FuturePay is designed to target an annual yield of approximately 4% per annum, paid monthly and growing with inflation. Backed by shares, it is also designed to give investors an investment which might be expected to grow in value over the long term, although capital is not guaranteed..
In practice when an investment in FuturePay is made, there is an investment in two strategies: 1. An investment into a Magellan global equities strategy; and 2. An investment into a Support Trust.
The purpose of the Support Trust is to underpin the predictable monthly distribution. It is funded using a reserving strategy.
A reserving strategy means that when the investment in global equities has a year of strong performance, some of those returns are ‘reserved’ and retained in the Support Trust. Conversely, in times of poor returns, the Pooled Trust will support the monthly income payments.
You can invest directly with Magellan or purchase units on Chi-X exchange under the ticker FPAY.
What does it cost?
The management fee is estimated at 1.52%pa
Pros
The investment participates in the capital growth of the underlying shares.
The investment is liquid i.e. it can be bought and sold easily.
Income is regular, predictable and more likely to be reliable than share dividends on their own.
Cons
The reserving portion is left behind when you sell your investment.
There is an element of capital risk with an investment in shares – you can still be in a position for selling for less than you invested
The level of income or capital is not guaranteed
There is only one investment strategy
Solution 3 – Qsuper Lifetime Pension
Super funds are being encouraged to offer lifetime solutions for their members.
QSuper’s Lifetime Pension is the first to market but more can be expected to follow.
These products will differ between providers and should be reviewed carefully to ensure it is right for you. At first glance you may think they may resemble lifetime annuities but in reality they are significantly different.
Who is it for?
Retirees who want a high degree of certainty in the income they will receive. It can be used to mitigate ‘sequencing risk’.
How does it work?
Whilst the underlying mechanics are complex, this retirement solution is quite straightforward.
A sum nominated by the investor is rolled from their superannuation into the Lifetime Pension Income product.
Based on your age and the investment sum, your lifetime pension is calculated. Generally, for the same investment, the pension will be higher the older you are. Pensions are reset each year on 1 July. It is anticipated the payment will increase over time but the extent to which it rises will reflect the underlying portfolio performance.
Due to the link to portfolio performance, there is a risk that income could also go down.
The design of the product is that your initial capital sum is paid back to you over your lifetime.
What does it cost?
This will vary between providers. As a guide there will likely be two broad fee categories:
Investment fee – the underlying pooled fund will have a fee that comprises of a base fee and potentially performance fees.
Administration fee – there may also be an administration fee paid to the provider.
Pros
It may boost your age pension entitlement (Note: 60% of actual income counts towards the income test and 60% of the purchase price counts to assets test to age 84 and 30% thereafter).
You will not have to worry about the longevity of your pension.
You will not have to worry about investment returns – you will have a high degree of certainty of your income and can budget accordingly.
Income payments are tax free when purchased with superannuation money (like an account based pension)
Payments are designed to increase each year, adjusted to reflect factors such as performance in the underlying pool of investments, fees and mortality experience.
Money back protection – some products may offer this. The product may be designed to pay you out your purchase price with any remainder going to your nominated beneficiary/ies. Note that this does not include earnings which stay in the pooled fund.
Cons
You will not benefit from any positive market movement which may improve your position. That is, there is no ability to grow your capital.
If you are an age pensioner subject to deeming, the income assessed from the lifetime pension may be higher than deemed income from other solutions.
Whilst the payments are designed to go up each year, they may also go down.
After a cooling off period, it is a permanent purchase. You cannot withdraw any capital.
If you have a spouse and fail to nominate them, they will no longer receive payments when you pass away. If you do nominate a spouse, starting payments are based on the life expectancy of the younger person (which means a lower starting payment).
You do not get to select your preferred investment option.
You have no individual account balance – your funds are pooled with all other investors.
Conclusion
Understanding what is most important to you as an investor helps define a strategy which will meet your long term expectations. Thinking through what you need, what you want, what risks you are prepared to take, your investment time horizon and your estate planning preferences will help lead you to those investment products best suited to meet your objectives.
It may be as simple as the account-based pension which many already use or it may be a combination of solutions working together to try to ensure your investments go the distance.
Disclosure Statement: This communication has been approved and issued by Sovereign Wealth Partners Pty Ltd ABN 18 607 071 367 Corporate Authorised Representative (No. 001233909) of Sovereign Capital Pty Ltd ABN 44 164 127 833, AFSL 456235.
General Advice Warning: Any advice included in this article and associated links is general in nature and does not take into account your objectives, financial situation or needs. If a product we recommend has a Product Disclosure Statement (PDS), you should read it before making a decision. Past performance is not a reliable indicator of future performance. We do not endorse any information from research providers that we provide to you, unless we specifically say so.
