At times like this in the share market, many retirees want to duck for cover and take out an annuity to guarantee a future income stream rather that take the volatility swings in the market.
There are many types of annuities. I’m going to focus on one that – in an exchange for a lump sum now – the provider will return a fixed amount each year, adjusted by the consumer price index (CPI) so that inflation cannot erode the income stream. On the death of the holder, the partner (I am assuming that there is one for simplicity), then receives the annuity until his or her death.
Running the numbers
While this might seem to be the way to go, the cost of the annuity must be taken into account. The ASFA Retirement Standard (May 2012) claims that an income of $55,080 per annum is needed for a ‘comfortable’ living standard for a couple in retirement, assuming that they own their own home.
Of course we all have our own definitions of ‘comfortable’ and while I can imagine living off $55,080, it is not the lifestyle I would like with seven days a week with nothing to do except eat, drink, travel, indulge in hobbies and hang out with family. I think it would be much easier to live off that if both were working during the week and often too tired to go out at night!
A major provider sent me a price for an annuity that would pay just over $1,000 per week for a couple that both happened to be 60 – just below the comfortable level. The price was a staggering $1,445,000! You have to pay for removing the risk of living for a very long time, variations in inflation and market conditions. And, at the end, there is nothing left for the kids, even if you die young. The annuity holders that live a long time are subsidised by those that don’t make it.
This $1.5 million amount seems a lot higher than the $850,000 amount often quoted. But on reading the fine print, that $850,000 figure assumes that you are earning 7% per annum, inflation is 3% per annum and that you run out of money after 22 years. To get 7% per annum you would probably need something like a balanced fund that takes on some risk (so the last few years would have shortened the fund’s life) and inflation could spike up at some time over the next 22 years again eroding the purchasing power of your lump sum. At least if you both die young, the kids can get something.
Here’s to a long life
Another industry standard is that a male’s life expectation is 84 and a female’s is 87. Of course it very much matters how old you are when the question is asked. A 90-year-old has a 100% chance of making it to 85!
I took a US university test this week to see what my life expectation is. I had to answer about 20 questions about my family history and lifestyle. I am 63 this month and, apparently, I have a 50% chance of living beyond my 84th birthday (and a 50% chance of missing it!). I have a 25% chance of not making it to my 77th birthday and a 25% chance of living beyond 91.
If I run out of money after 22 years (having semi-retired at 60), I have a better-than-evens chance of living off the ‘uncomfortable’ aged pension (if I followed the $850,000 option) and over a 25% chance of living off the pension for nine years (which is 91– 60 –22 = 9) and with the prospect of quite a few more years to come.
In my next few columns, I want to develop ‘compromise strategies’ that allow for some risk, but give the prospect of being comfortable to the end for much less than $1,445,000 – and my strategies are based on equity market volatility.
Ron Bewley is the director of Woodhall Investment Research [1].
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