The global financial crisis (GFC) has led to many retirees experiencing substantial declines in the value of their retirement savings. Members of self-managed super funds (SMSFs) in pension phase, in particular, have been hard hit with many having to sell assets in times of market downturn and forced to realise capital losses in order to meet pension requirements and lifestyle needs.
A strategy that is often overlooked is the use of an annuity as part of the SMSF’s investment portfolio.
A SMSF is able to purchase an ordinary annuity with a nil residual capital value (RCV) to cover pension payments for a period of time, say three to five years with the remaining assets invested in more growth orientated assets over a longer timeframe, like property.
This strategy allows growth assets to remain intact and allows them the ability to recover when markets are volatile. Meanwhile, you can rest assured that your income payments will be comfortably met and guaranteed over the selected term regardless of market conditions.
Some factors to consider when deciding the appropriate term for the annuity and how much to invest are:
• The timeframe over which you would like to secure their pension payments.
• Whether the annuity income is to cover all or only part of the pension payments.
• Your risk profile.
• The expectation over what interest rates are going to do.
The benefit of using an annuity in a portfolio’s income allocation, annuities generally provide a highly competitive return versus investments with a similar risk profile e.g. Term Deposits.
Annuities are able to offer an attractive return to investors as it invests both the amount used to purchase the annuity, as well as the additional amount of capital provided by the provider to support the guarantee, in a range of high quality assets. These investments will be carefully managed to match the duration of the obligation to investors. The rate offered by the issuer is ‘locked-in’ and is not diluted through the impact of management fees. This is an important differentiator when comparing the return of annuities to other investments such as bond funds.
Case study – Jack (65) has recently commenced an account based pension in his SMSF with a balance of $700,000.
He requires annual income of $45,000 (although the minimum payment from his Allocated Pension is only $35,000).
Jack decides that the fund should purchase a short-term annuity to cover income payments for the next three years. He wants to be certain that he will not have to sell down shares or worst case the property he recently invested in to make the minimum pension payments in that three-year period.
His SMSF purchases an ordinary income, three year nil RCV, 3% indexed annuity for $130,000. The annuity pays income of $45,615 (represents nominal rate of 5.28%) in the first year which covers Jack’s required amount.
He selects a 3% indexed annuity to protect against inflation and cover potential increases to the minimum requirement over the next three years.
His other assets in the fund are more skewed to growth assets.
For further information or to discuss your personal circumstances, please call Chan & Naylor Financial Planning on 1300 99 77 34 or send us an email.
Disclaimer: The above information is for general knowledge purposes only. Please take advice for your specific situation before investing in property. Every person’s personal situation is different and requires a different solution