Annuities keep money coming in until it’s all over
Instead of blowing KiwiSavings at 65, option offers income security.
Knowing how much of your KiwiSaver fund to withdraw after retirement is a balancing act. Picture / Getty Images
There’s a gaping hole in the KiwiSaver concept: What happens to the money when people turn 65.
Many retirees are treating it as a Lotto-style payout. Half of them are withdrawing their money and, of that number, most are blowing it on overseas holidays, cars, boats and consumer goods.
It’s early days with the scheme and as people’s pots of money get larger retirees might start to spend or save more sensibly.
One piece of good news is that the Retirement Income Group is shortly launching New Zealand’s first annuity aimed at KiwiSavers. Annuities provide an income for life, guaranteeing that retirees’ money won’t run out before they die.
In effect an annuity is longevity insurance. With traditional annuities the retiree takes the lump sum and hands it over to an insurance company, which guarantees a regular payment to the retiree until he or she dies.
On death any money left is the property of the insurance company and isn’t paid out to the estate. The sooner the retiree dies the more profit the insurance company makes.
Retirement Income Group chief executive Ralph Stewart says his company’s Lifetime Income product is different. The KiwiSaver pot remains the property of the retiree. The money is invested in a balanced fund from which a fixed sum of money is paid out to the retiree at regular intervals. If, for example, a retiree put $100,000 in, he or she could expect to receive about $100 a week for life.
The annual fee which is taken from the account is 0.95 per cent, which is lower than many KiwiSaver funds. The fund is taxed at the investor’s Pie rate. The capital can be withdrawn at any time. At the same time, says Stewart, the retiree also pays an annual longevity insurance premium from their KiwiSaver fund. This insurance premium guarantees that should their capital run out before they die, they will continue to receive the regular income for the rest of their lives – paid out of insurance.
The annual premiums are 1.35 per cent of the capital, which is taken from the fund, meaning the retiree doesn’t need to find the cash. If there is capital left when the person dies, it’s paid into the estate. The insurance profit comes from clients who die before their capital runs out.
Stewart says the product combines the best of both worlds. The assets are managed to last and at the same time the retiree gets certainty of income for life.
On the downside, it isn’t inflation proofed. That $100 a week won’t buy as much in 30 years’ time.
David Boyle, the general manager of investor education at the Commission for Financial Capability, believes as demand grows more innovative KiwiSaver retirement income products will be offered.
Boyle cites the example of deferred annuities, which are available in Australia, but not yet here. Instead of paying a lump sum into an annuity for an income from age 65, an individual might be able to pay less, but get a guaranteed income from a later date such as age 75.
There is little demand yet for annuity-style products, says Roger Clayton, head of wealth products at ASB. Only one in 350 customers over the age of retirement has chosen to set up a regular drawdown of funds from their KiwiSaver. But Clayton believes that as Kiwis’ KiwiSaver pots fill up investors will become more fiscally responsible and demand products to provide an income from their money.
He says KiwiSaver members should think twice before closing off their accounts in retirement.
KiwiSaver funds offer good value for money as an investment and could be a practical place to keep retirement funds.
In theory, there is no reason why providers shouldn’t produce an income-focused KiwiSaver fund that existing members can switch their money to when they reach 65.
Many financial advisers will create a draw-down plan for clients. Boyle says that may involve keeping the client’s money in KiwiSaver because the fees are generally lower than similar funds in the market.
The million-dollar question for retirees who don’t buy an annuity-style product is how much they can withdraw each year without using up the capital before they die.
Katie Whiffen, a retirement specialist at National Australia Bank, offered this rule of thumb: KiwiSavers who want their money to last should take their current balance, divide it by 20 and withdraw that amount each year from age 65.
Such formulas are based on assumptions such as sharemarkets increasing at a constant rate. Black swan events such as the dot-com crash, subprime mortgage crisis, global financial crisis and European debt crisis come along from time to time and throw returns into disarray, the Financial Services Institute of Australasia (FINSIA) points out. Calamities like those can have a big impact on how long retirement savings last.
What’s more, that rule of thumb calculation may not give you sufficient money for now. Working out what your income should be isn’t easy, says Michael Chamberlain, of Superlife. The variables include the balance of your KiwiSaver and other retirement savings, the period you need to spread your savings over, how your savings are invested and what the returns are.
Retirees typically spend 1 per cent less each year, so taking a larger withdrawal now, knowing they’ll spend less later, might work for some.
What’s more, some people need their KiwiSaver pot to pay for one-off expenses such as a new appliance, says David Wallace, AMP’s head of contemporary wealth management. Others need regular withdrawals for their day-to-day living expenses.
Typically, says Wallace, AMP KiwiSaver customers who also have an AMP financial adviser will be contacted each year to ensure their retirement savings spending plan is working. KiwiSaver-only customers receive letters and can contact an adviser at the firm to talk through the details of their investment.
Wallace says customers who take their money out of KiwiSaver and put it in a term deposit will see a lower return than those who keep it in even a conservative fund. Conservative funds are returning 6-7 per cent a year, he says, compared with 3.5-4 per cent for a term investment.
Considering that the retiree may live another 20 to 30 years, they might be better off in a fund that invests a chunk of their money in growth assets to keep pace with inflation. As much as 60 per cent of retirement income can come from portfolio growth after the age of 65.
The balance does need to change over time, however. As Chamberlain points out, as your life expectancy reduces, the portion of your future lifetime that is more than 10 years away reduces. “As a rule, you should generally not be holding shares unless you want to take on risk, or you have expenditure that will occur in at least 10 years’ time and you need to be protected against the impact of inflation. This gives you time for your investments to recover if the sharemarket goes down. It will do that every three to four years on average.”
SuperLife’s website has a good guide to the type of thinking that needs to go into retirement income at superlife.co.nz/thinking-about-your-retirement.html. Most calculators look at how much you need to save for your retirement, not what will happen to that capital when you need an income. A simple retirement withdrawal calculator can be found at financialmentor.com/calculator/retirement-withdrawal-calculator.