Retirement planning: Time to add annuities to the mix?

Annuities have a mixed reputation in retirement planning, but a combination of elements suggest they may be worth a second look.

Annuities have a mixed reputation in retirement planning. Not many investment products evoke strong reactions among investors and advisers, but annuities certainly make the list.

These retirement-income products provide a guaranteed regular income, either for life or a fixed investment term. But they’ve never been popular in Australia. For those who shun them, the reasons are many: too complex, too expensive, fees are too high, and little or no flexibility.

Now, a combination of elements suggest annuities might be worth a second look.

So, what changed?

First were changes made in 2019 around the way lifetime annuities would be treated from a Centrelink assets test perspective.

From this date, 60 per cent of the purchase price of a lifetime income stream, including a lifetime annuity, count as an asset for the purpose of the assets test.

This is up to age 84, or for a minimum of five years. From age 84 onwards, 30 per cent of the purchase price counts as an asset.

This is a big benefit for those sitting just above the assets test threshold, or who want to maximise their age pension payments.

But then Covid hit and interest rates plummeted, again taking the sheen off lifetime-income products.

There has since been a big move in rates. The cash rate has risen 13 times since 2022 and there are some annuities offering rates of 5 per cent-plus. This means you’re now getting above-inflation rates of return.

Once the annuity rate is locked in, it stays there for its lifetime, even though official rates may come down. Of course, this can also go against you if official rates push higher in future.

Be aware, inflation data out this week saw traders bump up their expectations of another rate hike this year.

One senior adviser told The Australian he had just recommended an annuity to one of his clients for the first time in a decade.

“What we like about it is there’s a slight benefit from the Centrelink assets test. So that allowed our client to pick up a small pension, which reduced his aged care fees. So it’s good for people who are entering into an aged care facility,” he says.

While annuities may be a good option for those near the upper limits of the threshold of the Centrelink assets test, advisers don’t typically like them for wealthier retirees who can’t get the age pension benefits.

“Why would you lock up your capital for a lifetime to get 5 per cent when you can put it into a term deposit at 5 per cent,” says adviser Paul Nicol of GFM Wealth Advisory.

“Avid supporters of annuities will argue otherwise, but in my business we really only see the application of lifetime annuity as a tool to either get our client eligibility for the age pension or to enhance their level of age pension,” he says.

Next generation annuities

The third change which has shifted sentiment are the products themselves. New iterations of annuities are much more attractive than their older peers, advisers say.

“Annuity providers have definitely improved the products in the market. There are now better outcomes from an estate planning perspective, including, if say, somebody passes away early in the annuity term,” Nicol says.

One of the chief complaints of the traditional annuity was, upon death, the life insurer would keep the account balance. New annuities solve for this by handing back any remaining balance to family members if a person dies early.

Alongside lifetime annuities are next-generation products which providers hope will attract more interest. Some look to the US, which has a more developed market in this space.

Jasmine Jirele, CEO of Allianz Life Insurance of North America, says many of the solutions in the US market could translate well locally.

“We know fundamentally the challenges that retirees face in both markets (longevity risk), and the ability to push that off to the insurer is definitely a trend that transcends both markets,” she says.

“Contributing to the popularity of the new generation of products in the US was the ability to balance out the market participation and upside, along with having a buffer on the downside,” she says.

Allianz Life president and chief executive officer Jasmine Jirele. Picture: Jane Dempster

In Australia, Allianz Retire+ offers the Allianz Guaranteed Income for Life (AGILE) product. This hybrid offers lifetime income like a fixed annuity, but starts with a growth phase to drive potentially higher returns.

In the growth phase, clients can have exposure to assets including Australian or global stocks

— and these come with a buffer. So, if the market falls 10 per cent, Allianz absorbs the loss. Anything after this comes out of the account balance.

So why not just stick with investing in the stock market and then go straight to a lifetime annuity rather than a hybrid?

“The financial adviser can model, with certainty, what the income is going to be and the core reason for that is every year you defer turning income on (with AGILE), the guaranteed income rate goes up by 35 basis points,” says Allianz Australia Life Insurance CEO Adrian Stewart.

While next-generation annuities give retirees more flexibility and control, they can come with a trade-off. Some advisers warn these hybrids may promise equity-like elements and annuity-like benefits but don’t always deliver.

As well, some argue hybrids are more complex compared to the more simple approach of splitting a nest egg into a term deposit or annuity and a share-based ETF, which can get the job done just fine.

Anyone considering a hybrid should also check if they qualify for the Centrelink assets test benefits — not all of these next-generation annuities do.