“IT’S quite likely we’re going to be in this world of low interest rates for years, perhaps decades, because it’s driven by structural factors in the global economy,” Phillip Lowe, Governor of the Reserve Bank of Australia recently said.
That’s bad news for people who have their money in term deposits, but there is an alternative.
Lifetime annuities pay retirees a monthly sum indexed for inflation guaranteed for life, no matter how long (or short) you live.
Buying a lifetime annuity is like putting money in a term deposit, only there are two important differences.
First, the return is much better. Term deposits return 1.25 per cent annually at the moment. Lifetime annuities return between 4 and 5 per cent.
Lifetime annuities are indexed annually by CPI.
Second, at the end of the term, the money you put in your term deposit is still there. It’s returned to you or you roll it over for another term. With lifetime annuities you generally speaking don’t see your money again, or not all of it. You buy your annuity and it pays you an indexed income until you die. The term of your lifetime annuity expires at the same time as you.
Higher return, more risk?
Yes, but not much more.
The Australian Prudential Regulation Authority (APRA) requires institutions to put their own money into the statutory lifetime annuity fund to make sure it’s in their interest the statutory fund performs well. There’s nothing like self-interest to motivate an investment banker.
APRA monitors the statutory fund’s investments to ensure that it can pay investors as agreed. If at any time the statutory fund does not achieve investment returns that are sufficient, institutions must cover the shortfall. APRA can also require institutions to invest more of their own money into the statutory fund or require them to change the statutory fund’s investments.
It can still all fall over, but it’s unlikely.
A lifetime annuity can be any size, generally starting from $10,000.
A company called Challenger has a virtual monopoly on lifetime annuities, but this may change. Superannuation funds are increasingly finding that their members want retirement income streams after having made contributions during their working life.
If competition takes off, as it is likely to do, returns may be even better than between 4 and 5 per cent. But if you are addicted to term deposits, between 4 or 5 per cent is already a huge improvement right now!
A riskier alternative may be to buy shares in Challenger. It works off a target rate of return of 14 per cent.