Be honest, who hasn’t had someone seek advice with that question?
You cannot be too careful in what you say, particularly in these tricky times of investment advice bans and uppity pronouns. I may have mentioned before that I don’t give advice unless someone pays, so it follows that anything I say cannot be advice if you are not paying, right?
Perhaps not. It used to be said in relation to the common law that in England, everything is permitted unless specifically banned. In Germany, everything not specifically permitted is banned. In France, everything is permitted even if it is banned. In Russia, everything is banned, even the things that aren’t.
Well in Australia, we seem to be moving towards the German model. So it is with some trepidation that I press on, not giving advice of course, but if I were to give advice, what would it be?
Today’s topic is the pending retiree who has built up a savings pot in tax sheltered superannuation and is now considering how to use it in retirement. To generalise, there are really only two ways: self management or annuity. Yes, there are a lot of variations within those categories but differences are comparatively small, and are not differences in principle. Self management means, in essence, retaining the risks of investment and longevity and retaining the administrative and decision making burden. It should be remembered that administration and decision making becomes progressively harder as people age, while longevity and investment risks progressively reduce. There’s always something to worry about.
Meanwhile, buying an annuity means freedom from administration, decision making, investment risk and longevity risk. Without a doubt, annuities are the most efficient use of capital to deliver a dependable retirement income to a cohort of retirees. The word cohort means for the group as a whole. Some will die early and in doing so fund the longer lifetimes of the annuitants who remain in robust rude health.
There are times when annuities are a fairly boring business, even as they perform a worthy function in society. Here’s my advice that would go to paying readers: we are not in those times.
We now have inflation that appears to be setting in for the long haul. No country has ever emerged from an inflationary experience without pain. Some have still not emerged. Are you watching Venezuela? The latest data available on tradingeconomics.com has the annualised rate of inflation falling from 439% in March 2023 to 436% in April. No doubt about it, the Venezuelan statistics bureau staff have fine tuned their measurement of inflation into highly precise data.
What does that kind of inflation do to the annuitant’s purchasing power? Destroys it.
What does inflation do to the annuity provider who sold inflation linked annuities? Probably will destroy the provider, unless there are seriously effective mitigations written into the policy, in which the annuitant’s purchasing power is destroyed.
What does inflation to do central banks? Makes them jack up interest rates which destroys the value of the assets of the annuity provider and introduces the possibility of insolvency. So the counterparty risks have increased.
Now consider mortality gains and losses. There is a generalised wave of excess deaths continuing in many countries around the world, including Australia. The Actuaries Institute measured the rate of excess deaths in 2022 at 12%, mostly in the older age groups. For an annuity provider, excess deaths mean early deaths relative to what was assumed would be the case when determining annuity prices. So, excess deaths will be a source of profit and therefore a stabilising influence on solvency. Unless that provider also provides life insurance in its suite of products in which case excess deaths are a source of loss. Over time, assuming the pattern of mortality stabilises, then what is currently considered an excess in deaths will become normal, and the pricing of annuities will catch up and as a source of gain or loss, that aspect will have been neutralised.
So back to our pending retiree; what should he or she do? (Editor’s note: are you allowed to say that?) This is not an easy question to answer and I think the push toward lump-sum accumulation superannuation that began in this country in the late 1980s has not been beneficial for the typical retiree. The stress and complexity is enough for anyone, even if they are financially literate and still able to cope with the decision making. I remember a time in the late 1980s when a work collegue with retirement age parents explained that annuities were at that time too good to refuse and he advised his parents to buy one. Then, inflation was falling, interest rates were high but on the cusp of falling, annuity prices were low and would eventually start to rise.
These days, annuity prices are high, interest rates and inflation are rising and, while that will reduce annuity prices in the years ahead, that doesn’t help the new retiree in today’s times. What about the alternative? Not easy either but there is greater scope for diversity in investment risk and the greater flexibility may permit the alert investor to react to events and mitigate the worst trouble. No one should doubt the seriousness and complexity of the task.
3 thoughts on “What would you do, if you were me?”
Agreed. If you don’t like traditional annuity rates (given current market conditions) then investment-linked annuities let you enjoy freedom from administration & [most] decision making and longevity risk. They offer a menu of investment options. But beware – if you’re market predictions are wrong the level of income can go down as well as up.
As you say, annuities are without a doubt the most efficient use of capital to deliver a dependable retirement income to a cohort of retirees.
P.s. *This is not advice!*
David, you might like this type of annuity. It lets you ‘unbundle’ the annuity. https://www.superguide.com.au/in-retirement/investment-linked-annuity
Yes, good developments. In broad terms this is on the self management end of the spectrum: retaining the investment risk and using an instrument to hedge longevity risk.