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C & D

Annuities – Who is the Winner?

Increasing numbers of people who are members of KiwiSaver schemes are becoming eligible to access their savings. This is because they have reached the age of sixty five. Some of these people have significant amounts of funds. There has been some debate on what they should do with the monies. One option that has been talked about is to buy an annuity.

Annuities are typically provided by financial institutions such as life insurance companies. The investor invests a certain amount with the company, and in return receives a set regular amount of money. The institution takes the risk that the investor may have an above average life expectancy. If the investor for example dies within a short period of time, the company will make a supernatural profit. The excess does not go to the investor’s estate.

We understand that annuities are not currently available in New Zealand. However it is possible that at least one financial institution may be interested in offering them in the future.

Here are some thoughts on annuities.

  • The annuity provider will invariably be the winner. The only exception is likely to be when the investor lives to a much older age than expected.
  • The investor’s estate is invariably the great loser.
  • Annuity provider’s actuaries always act in their employers’ best interests. They use very conservative assumptions.

If we look at the following graph using Research House Farrelly’s assumptions, we see the range of potential investment outcomes. Between the lines of the optimistic and pessimistic scenarios represents 95% of the likely investment outcomes. An annuity provider would probably use an outcome similar to the Pessimistic one. So they stand to benefit from the difference between the actual outcome (usually at time of death) and the pessimistic one. So it could be an extremely profitable proposition for the provider over the long term.

For illustrative purposes we have used a $100,000 lump sum at age 65, with a life expectancy of 90 and an annual drawdown of $4,500.

If instead of buying an annuity, a balanced or conservative risk profile portfolio were established, the investors’ estate would benefit by the difference between the pessimistic and actual return. This is using the same $4,500 per year annual drawdown.

From an investment perspective it would be illogical to buy an annuity. However an annuity would provide peace of mind, but comes at quite a cost, both in upfront fees, but more likely for the investor’s eventual estate.

We would recommend that an investor who is eligible to withdraw their KiwiSaver scheme savings, seek independent investment advice. There are a number of options available, and it is important to make the best informed choice. After all, it will impact on your retirement and possibly estate.

Disclaimer

Steven Barton (FSP 32663) and Susan Pascoe Barton (FSP 32382) are Certified Financial Planners and Authorised Financial Advisers.  Their initial disclosure statements are available free of charge by contacting them on (07) 3060080 or they can be downloaded from www.pascoebarton.co.nz. This column is general in nature and should not be regarded as personalised investment advice.