If rates have peaked it’s time to look at fixed-term deposits and annuities

For those who go from not having an age pension to receiving a partial age pension by using an annuity, it will unlock the Commonwealth Seniors Health Card.

Cash, term deposit and certain bond investors are having their best Christmas in years after a sharp increase in the RBA cash rate over the past 18 months, while mortgage holders hope we are close to the peak of the current rate rise cycle.

With inflation now below 5 per cent and slowly moving back down towards the RBA’s 2 to 3 per cent target band, there is a growing view from experts that 2024 will be the year when we start to come down the other side of the mountain and see cash rate fall.

If you are one of the lucky ones who have been cashed up and enjoying a strong level of interest rolling into your bank account from your defensive investments, now is the time to think about what you can do to prolong the high returns before the inevitable drop occurs.

Just as mortgage holders scrambled to lock in sub 2 per cent fixed-rate mortgages for up to five years during the 2020 Covid-19 lows, cash-orientated investors should now be thinking about whether now is the time to lock in the attractive cash rates for periods of up to five years.

The big four banks are currently offering five-year term deposits at 4 per cent while annuity provider Challenger is offering a five-year term annuity at 5.05 per cent. Although you receive 100 per cent of the capital back from the annuity at the end of five years, unlike a bank term deposit it is not covered by the $250,000 federal government guarantee on bank deposits under the Financial Claim Scheme.

Challenger chief economist Jonathan Kearns says: “Recent soft economic data has seen financial markets pricing no further increases in the cash rate, with the first cut around the middle of next year and a second cut later in the year.

“I think it’s possible we won’t see cuts until the end of next year at best. But with the cash rate not expected to increase further, we are probably around the peak in 10-year interest rates.”

Although 4 to 5 per cent is a strong return when compared with the sub 1 per cent term deposit rates on offer when the official cash rate was 0.1 per cent a few years ago, many will not be sold on the idea of locking in money at interest rates below the inflation rate for such long periods of time.

Another option to reduce the impact of the looming reduction in cash returns is to have a look at annuities as part of your retirement income mix. Although there is not a 100 per cent correlation between the RBA cash rate and the internal rate of return (IRR) of an annuity, there is a linkage as part of your annuity investment gets moved into long-term bonds by the annuity company to help fund your regular annuity payments.

Back in December 2020, a $100,000 Challenger lifetime annuity with indexed payments for a 65-year-old male with a 23-year life expectancy provided a year-one payment of $3950, representing a 1.49 per cent IRR.

Fast forward to December 2023, the same annuity would provide a year-one payment of $5134 resulting in an IRR of 3.74 per cent.

Although this rate may still seem low to some, a few things to remember about annuities; many of them offer a 100 per cent return of capital guarantee in the event of premature death.

Each offering is different so it is important to read the fine print, but as a rule of thumb 100 per cent of the annuity purchase price can be returned if you pass away within half of your expected life expectancy, then a lower amount on a decreasing sliding scale if you pass away closer to your life expectancy.

Annuities also have the potential to provide a Centrelink boost for those who are on the cusp of receiving an age pension, or those in the part-pension band due to excess assets.

Lifetime annuities benefit from a 40 per cent reduction in the assets and income tests. In other words for a $100,000 lifetime annuity, only $60,000 is counted towards the Centrelink assets test.

For those who go from not having an age pension to receiving a partial age pension by using an annuity to creep under the maximum assets threshold, which is $667,500 for a single homeowner and $1,003,000 for a homeowner couple, getting just $1 of age pension income unlocks the Commonwealth Seniors Health Card which can be worth thousands of dollars per year.

And finally, perhaps you want to bet against the actuaries who work out monthly annuity payments based on our estimated life expectancy: Well, if you have strong family genes, the non-guaranteed $0 capital return lifetime annuity may be the one for you.

It provides a 5.11 per cent return if you survive to your expected life expectancy, and increases for every year that the annuitant outlives the averages.

If you survive your life expectancy plus five years, your return increases to above 6 per cent as you received an extra five years of annuity payment the annuity provider did not expect that you would be alive to receive.

James Gerrard is principal and director of Sydney financial planning firm www.financialadvisor.com.