Annuities in a nutshell

Investing in cash is simple right? Well in the most part yes. However, different investment options do exist when it comes to deciding how to invest in cash or fixed interest investment options. But first let’s get a little perspective. Historically people have felt comfortable investing in cash and certain fixed interest investments because of their lower risk profile. Cash is generally seen as ‘liquid’ meaning you can get your hands on it without any change in underlying capital value. But not all cash products are the same. For some retirees, annuity products are used within their investment portfolio mix to add diversification and other benefits such as increased Aged Pension Centrelink payments.

So how do annuities work?

The key feature of most annuities is that most promise to provide you with an agreed income for a guaranteed period, or your life. One of the main benefits of annuities is that you have certainty about the income you will receive over time. You can choose to take the income only, or a combination of both income and capital over time.

Is an annuity right for me?

Know your “Risk tolerance”! If the sub-prime crisis (aka “GFC”) still gives you heart palpitations you might want to try dependable and safe investing.  More often than not, retirees choose a portion of their portfolio to invest in cash or annuities, whilst diversifying across other important asset classes such as shares and property. The lower a retiree’s risk tolerance (all things being equal), the higher weighting they might invest towards cash and annuity type products. However it cuts both ways. While retirees that prefer ‘safe’ cash and annuity type investments might feel more comfortable sleeping at night, the reality is their underlying capital won’t increase over time to hedge against increases in the cost of living via inflation. The benefit of a properly diversified share and property portfolio held over the long term (i.e. 10 years plus) is that the underlying value often increases. Of course no one can provide an iron clad promise the past will repeat itself. Timing or ‘when’ you invest can have a big impact on success, particularly if you need regular income from an investment portfolio. Have a look at this video by Professor Moshe Milevsky on behalf of Challenger (an annuity product provider) explaining this point in more detail.

What else should I know?

In an unprecedented era of low interest rates that we currently find ourselves in, the returns from cash and annuities for retirees is quite low. Many financial commentators suggest diversifying across all key asset classes might be the best hedge against an uncertain investing future. Investing in lifetime annuities can also provide other benefits beyond mere ‘safety’. Life time or certain fixed term annuities may also be assessed by Centrelink favourably allowing a retiree couple to increase their Aged Pension entitlements.

So what will you learn in our Diploma of Financial Planning course related to annuities? First, know your product! Research the prospective annuity provider. The good news is we have a whole module dedicated to investment theory (Module 2) of the Diploma. We cover Cash and Fixed Interest in detail, and how annuity products work. So what is our view on annuities?  Before any financial planner provides annuity advice, they should understand the annuity product inside and out. This should involve making sure they are able to fully explain complex contracts features to their clients, fees, exclusions and any restrictions. Remember it’s your client’s hard earned money, and in retirement there is less scope to remedy bad investment mistakes. Good luck 🙂