Retirees are rediscovering insurance bonds as a way to supplement their retirement income from within a tax paid environment and still maintain access to their funds, says Richard Atkinson, AUSTOCK Life.
Insurance bonds are emerging as a solution for nervous retirees who want an income stream solution that provides a guaranteed income as well as control over where their money is invested and full access to their funds.
Financial planners and wealth management firms are combining the fixed income guarantee of annuities or Account Based Pensions (ABP) with the flexibility of insurance bonds.
Case Study: Retiree maximising retirement income with two income streams
Sixty-seven year old retiree Max Conroy (not his real name) has inherited $650,000 from his late mother’s estate. He has an ABP in place which provides him with a modest income. He wants to use this inheritance to set up an income stream.
Max is not enamoured with current bank interest rates or those offered by annuities. As he is of good health he believes he will need to invest for at least 20 years and wants flexibility built into his investment choice. Also, he didn’t want the money tied up in case a need arose.
Buying an annuity meant that Max could not choose how the fund manager invested his money and he would not benefit from any outperformance in the underlying investments. But he had peace of mind knowing that he had an income, albeit fixed, for his chosen term.
However when discussing his plans with friends in a similar situation, he realised that accessibility to his capital would have restrictions. He could not take money out of the annuity as a lump sum and, where he could, might get less than he invested.
“My friends had children a bit older than mine and were planning to help them out with a deposit for a house. I realised if I put all my money into an annuity that should I need to make any withdrawals for similar reasons, it could be quite expensive,” Max said.
A disadvantage with guaranteed products like an annuity is the lack of flexibility because your money is tied up. If you need a hip replacement or want to pay for a child’s wedding, too bad.
Instead, with the help of his financial planner, Max invested in an Austock Imputation (insurance) bond to provide both the flexibility and accessibility he wanted. He was able to establish a flexible monthly payment from the bond and take advantage of the 30% tax offset to reduce his overall tax position. He is able to stop, start or vary payments at will and can add unused income back into the bond. This compliments his ABP well and he can move the portfolio from ‘balanced’ to ‘conservative’ as he needs to match market conditions.
“The insurance bond has been a forgotten investment product which is starting to re-emerge among planners. Money is slowly moving back in to this highly flexible tax structure” said Richard Atkinson.
Imputation bonds definitely have some strong features in the form of uncapped contributions, flexibility of investment options, the benefit of a tax offset for withdrawals in its early years (this can be re-set via the 125% rule, if advantageous) and tax free after ten years. Importantly for Max, he would have access to money regardless of his age.
“Having lived through the worst sharemarket downturn in a generation and seeing the latest volatility, it is understandable that retirees living longer than their forebears are increasingly seeking products that offer a guaranteed steady income stream,” observed Mr Atkinson. “But it is possible to have the best of both worlds using a strategy that combines both an insurance bond with an annuity or an ABP.”
A more conservative approach to Max’s case, given that some retirees really like Capital Guaranteed investment, might be to invest $250,000 in an insurance bond and purchase a term annuity for $400,000.
The imputation bond, split between say, the term deposit fund (40 per cent) and the Perpetual Balanced Growth fund (60 per cent)*, based on the historical five-year returns (5.1% per annum after fees and tax), this portfolio would allow Max $20,000 a year for 20 years with some balance still remaining.
The term annuity, meanwhile, would pay a guaranteed $20,000 a year for 20 years. The annual payment stream representing 2.5% per annum after fees.
Interestingly, both the imputation bond and annuity pay out the same amount each year despite the wide differences in the initial investments.
However there are several underlying differences. After 20 years, Max is left with a balance of $164,553 in the annuity. In contrast, the bond has about $20,000 left in it despite an initial investment of $250,000 because the bond’s underlying investments were in conservative/balanced assets.
Max effectively has the best of both worlds:
- Regular income of $40,000 with half from the annuity and the rest from the bond
- Gives the option of helping out children if he chooses
- Can allow some effective estate planning with bond should he suffer an early death.
*Note: past performance is not an indication of future performance.
