Annuities have always been a hard sell to Australian retirees and changes to the age pension assets test from January 2017 will make that harder.
However a simple strategy could help some retirees reduce the effects of the changes.
The asset test changes will significantly reduce the pension income available for people who have assets outside the family home above trigger levels.
Currently a home owning couple can hold $1.17 million or a single home owner $791,750 in other assets and still receive a part pension. Under new rules those figures will be $823,000 and $547,000 respectively.
Those reductions will be achieved by increasing the “taper rate” under the age pension assets test.
For every $1000 someone has over the asset limits in the current system, their pension drops by $1.50 a fortnight. That will be doubled to $3 next year.
Annuities made (almost) easy
An annuity works like this. A consumer pays a lump sum to a provider who guarantees to pay out a given income, either for a set number of years or for life, depending on the product.
Under the new assets test taper rate, anyone wanting income security in later life through buying an annuity will have to stump up more cash to achieve the same level of income they had before the changes, if they have triggered the asset limits.
That’s because they will have to make up for the loss of pension income.
The pinch will be felt in the first years the annuity pays out to its owner, because its value will be higher in the eyes of Centrelink than later on when some of the capital values have been paid down.
Cash in if you can
Phil Gallagher, retirement policy advisor with Industry Super Australia, says rather than committing more capital to an annuity to make up the difference, a useful strategy could be to cash in other assets earlier.
“Buyers of annuities, who are in the asset test range, may wish to drawdown more heavily on other assets to maintain spending at the same level as it was before the asset test change. “
That strategy is effectively an asset rebalance. Non-annuity assets are reduced meaning the effects of the tighter assets test are mitigated.
As the annuity ages its capital value falls but the income it pays under its providers promise stays the same. Consequently the pension payed increases balancing the loss of other assets.
The concept of annuities was supported by the Murray enquiry into the financial system in 2014. It found that returns from such products “could be 15 to 30 percent higher than those from the current typical strategy of drawing the minimum amount from an account-based pension,” Revenue and Financial Services minister Kelly O’Dwyer told a conference last week.
Not high on the retirement hit parade
However Australians haven’t been falling over themselves to buy annuities, as this chart from the Australian Prudential Regulation Authority shows.
The thin, light blue band marking is minuscule $359 million paid out by annuities in the June 2015 year. That compares to the $15.6 billion from more conventional superannuation sources.
Annuities have also suffered from the low income environment because the income they pay out is an amalgam of interest rates and returns of capital. Back in 2013, the average return on an annuity was estimated to 5.6 per cent by market observers. Today it’s closer to 3.6 per cent, they say.
David Simon, principal with advisory house Integral Private Wealth, said annuities are particularly useful in the final stages of life when income security is paramount. “They can play a part for people going into aged care,” he said.
Annuities can only be offered by life insurance companies and the market in Australia is dominated by Comminsure and Challenger. Comminsure does not reveal the size of its annuity business, but Challenger grew its sales by 22 per cent to $2.8 billion in the 2015 financial year, the last reported.
The annuities sector should get a boost from moves to make deferred annuities tax free with the new superannuation reform package currently before Parliament.