Rodney Lay runs a ruler over products that are designed to address the key concerns of retirees.
Over the past few years, a number of new products have emerged that target the retirement segment of the Australian investment market. They are designed to address key needs/concerns for retirees – income stability, income sequencing risk, longevity risk, lifestyle risk – and consequently provide peace of mind.
Standard & Poor’s Fund Services recently rated two such products – specifically, a lifetime variable annuity, referred to as a “guaranteed minimum withdrawal benefit for life” product (GMWB for Life) and a “single premium income annuity” for life product (SPIA). In our analysis, we found that, on average, the GMWB for Life products available in the Australian market do not provide an effective guarantee against inflation risk, with real income expected to decline over the longer term. Similarly, the commutation value (CV) is expected to be materially lower than the initial investment amount. The particular SPIA product we reviewed provides retirees with complete income certainty (subject to the financial viability of the issuer), with income guaranteed to increase in nominal terms and remain constant in real terms. However, it ceases to pay a CV after year 15 and is therefore inappropriate for estate planning.
Product features
There are three GMWB for Life products available in the Australian market: Money for Life, issued by OnePath (formerly ING); Macquarie Lifetime Income Guarantee (MLIG), issued by Macquarie Life Ltd; and North Protected Retirement Guarantee (PRg), issued by AXA. In addition, Challenger Life Company has issued a SPIA product called Liquid Lifetime.
Guaranteed minimum annual income level
GMWB for Life products guarantee to pay a minimum level of annual income for the rest of the retiree’s life (and the spouse’s life, if the spouse option is selected). The annual income payment is based on a fixed income rate multiplied by what is referred to as the “income base”. The income rate may range from 4 per cent to 6 per cent per annum, depending on the particular product and the retiree’s age when entering it. Typically, the rate is 4 per cent for a 60-year-old investor, increasing to 5 per cent for a 65-year-old, and remains constant for the rest of their life. The income base is the value of the investment on the most recent annual anniversary date.
The income payment is market-linked by way of a portfolio of several underlying managed funds. If on the annual anniversary date the performance of this portfolio, minus all costs and payment of annual income, exceeds the income base, then it will increase to match the investment value on the anniversary date. Consequently, the minimum guaranteed income payment will increase to an amount equal to the income rate multiplied by the new and higher income base. The income base and annual income payment may increase, but never decrease. However, while the nominal value of income payments cannot increase, in real terms income payments can decline. The investment value minus all costs and annual income payments is referred to as the “account value”.
For example, if a retiree invests $1 million into the product at age 65, then they will receive a minimum of $50,000 per year (5 per cent per annum, multiplied by $1 million). Assuming portfolio net performance of 10 per cent and total fees of 3 per cent per annum, then the account value is equal to $1.02 million. As this exceeds the current income base, the base will increase to $1.02 million and the annual payment to $51,000.
With the Liquid Lifetime product, the annual payment is also based on the retiree’s age at investment. Currently the rates range from 4.9 per cent (55-year-old male) to 8.2 per cent (80-year-old male). Every year, the income payment increases at a level equal to the CPI. Income returns are not dependent on market performance.
CV payments differ between products
The second return component is the CV payable on the death of the retiree or surviving spouse where the spouse option is selected. The CV will transfer to the estate or, where the spouse option has been selected, to the surviving spouse. The CV is also market-linked and equal to the account value at the date of death. It may be materially lower or higher than the initial investment amount.
With the Liquid Lifetime product, there will be a CV for the first 15 years only. After that, if the retiree dies, nothing passes on to their estate. This is an implicit fee. To compensate investors, Liquid Lifetime needs to provide a higher level of annual income relative to GMWB for Life products.
Topic of fees polarises advisers
Product fees appear high – potentially up to 4 per cent per annum – depending on a range of variables, including the management expense ratio (MER) on the underlying managed funds. This topic tends to polarise advisers. Some believe the levels represent an acceptable “insurance” premium for the guarantee and the peace of mind it provides. However, others believe fees are excessive and will have a significantly adverse impact on the effectiveness of these products.
GMWB for Life versus SPIA products
In our view, Liquid Lifetime provides a superior income solution compared with GMWB for Life products currently available in the Australian market. But the converse applies in relation to estate planning – for which it is unsuitable – and it also lacks flexibility.
I think you would be better to choose a term deposit over these products any day of the week..If you need to make 9% with a balanced fund to net 5% you are just not going to see any increase..sure you may in the early years if you are lucky – but once you “fall behind” in the asset value, you will never recover it..these products are all about flogging..and if you analysed the advisers selling them you would see my point.