Clarity needed on deferred annuities
Among the government's proposals likely to be considered favourably by the Coalition, should it win power, is the one to give "deferred lifetime annuities" the same tax concessions as other superannuation assets. That should interest anyone worried about outliving their retirement savings.
Deferred lifetime annuities are longevity insurance. Someone uses a portion of their super savings to buy the annuity. The annuity starts paying an income only once the purchaser reaches a certain age. It keeps paying the fixed income, probably adjusted for inflation, until the purchaser dies.
Those who die early lose out and those that live longer, win.
Annuities provide retirees with peace of mind that if they run down their superannuation savings, they will have the annuity kick-in and have more than the age pension to fall-back on. As it provides a fixed income, the purchaser escapes the vagaries of investment markets. Financial institutions do not provide deferred annuities. That's because deferred annuities would be taxed as if they are generating income from the purchase date, rather than from the deferred period. If the proposal to tax them more favourably and treat them like any other superannuation asset becomes law, insurers will start offering them.
In a recent research note, JP Morgan said a deferred annuity providing an income of $25,000 a year in today's dollars could cost about $40,000 for a 65-year-old looking to commence drawing-down income at age 85.
Those wanting to buy a deferred annuity would have to shop around. Insurers would likely provide a quote that is good for a week or so. That is because there are many variables in their pricing. These include the age of the person when they buy the annuity, the age at which the deferred annuity starts paying income and their gender and life expectancy. Interest rates and outlook for interest rates also play a role in pricing. Another important part of any decision to buy an annuity is trust in the institution standing behind the annuity. Insurers are well-regulated and have to meet minimum capital-adequacy requirements. But an annuity may not start paying an income for 20 years. Changes in the financial services industry over that time are likely, including merger and acquisitions among annuity providers. Superannuation rules will change. Maybe the product is no longer sold by the insurer.
Do you want to be left at age 85 holding one of the insurer's "legacy" products?
As JP Morgan points out, there are a number of reasons why retirees could decide they can do without deferred annuities. They include that once a deferred annuity is bought, the money used to buy the annuity will not be passed on to children in the event of an early death. However, in a competitive market, deferred annuities that pay a death benefit could be offered.
Frequently Asked Questions about this Article…
A deferred lifetime annuity is a form of longevity insurance bought with a portion of your superannuation. You pay now and the annuity begins paying a fixed income only after you reach a specified later age. It typically keeps paying (often with inflation adjustments) until you die, providing guaranteed income if you live a long time.
The government has proposed treating deferred lifetime annuities the same as other superannuation assets for tax purposes. If enacted, that tax concession would make deferred annuities more attractive and likely prompt insurers to offer them, helping retirees worried about outliving their retirement savings.
Insurers largely don’t offer deferred annuities now because they are taxed as if they generate income from the purchase date rather than from the deferred period. That unfavourable tax treatment makes the product uneconomic for many providers.
Research cited by JP Morgan estimates that a deferred annuity paying about $25,000 a year (in today's dollars) could cost roughly $40,000 for a 65‑year‑old who wants the income to start at age 85. Actual prices will vary by provider and assumptions.
Pricing depends on many variables — your age when you buy, the age the income starts, your gender and life expectancy, current interest rates and rate outlook. Insurers typically issue quotes valid for a short time because these inputs change, so it’s wise to compare offers and understand assumptions.
Deferred annuities give retirees peace of mind by providing a guaranteed future income stream that can top up the age pension if savings run low. They remove exposure to investment market swings and act as insurance against living much longer than expected.
Downsides include the risk that you die early and the money used to buy the annuity is lost to heirs (unless the product includes a death benefit). There’s also provider risk — industry changes, mergers or regulatory shifts over long deferral periods could affect the product, and a purchased annuity might become a ‘legacy’ product no longer sold.
According to the article, despite extensive coverage, the proposed superannuation changes — including more favourable tax treatment for deferred annuities — are unlikely to be legislated before the federal election in September.
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