Maximising Retirement Income

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1 Maximising Retirement Income Michael Rice Alun Stevens Rice Warner 2015 This presentation has been prepared for the Actuaries Institute 2015 Actuaries Summit. The Institute Council wishes it to be understood that opinions put forward herein are not necessarily those of the Institute and the Council is not responsible for those opinions.

2 Introduction Entering retirement is a complex decision What income to draw What products to use How to use those products Balance between income and capital return Balance between early income and old age income

3 Introduction We consider the optimal use of retirement products Analyse the total value delivered to a retiring cohort over their lives Aggregate Age Pension Aggregate pension drawdowns Capital Return on death

4 Earnings rate on account-based pension Price inflation (CPI) Wage inflation (AWOTE) Deflator Simple model Assumption Standard: 7.5% p.a. after tax and fees 3.0% p.a. 4.0% p.a. Wage inflation rate Annuities are linked to price inflation (CPI). The Age Pension is linked to wage inflation. Mortality per Australian Life Tables incorporating 25-year improvement

5 Scenarios Combinations of Account Based Pensions (ABP) and Annuities plus Age Pension Immediate and Deferred purchase of annuity Income is optimised to provide level real incomes for periods specified 50% Life Expectancy (50LE) 75% Life Expectancy (75LE) Retirement accounts of $100k, $250k, $500k and $1 million Single Male Aged 65

6 $500k: 50LE ABP

7 $500k: 50LE ABP + 25% IA WCR

8 $500k: 50LE ABP + 25% IA WOCR

9 $500k: 50LE ABP + 25% IA WOCR Def Buy

10 $500k: Imm Annuity

11 $500k: 50LE ABP for comparison

12 $500k: 75LE ABP

13 $500k: 75LE ABP + 25% IA WCR

14 $500k: 75LE ABP + 25% IA WOCR

15 $500k: 75LE ABP + 25% IA WOCR Def Buy

16 Which is better value? Early income versus later income Income versus preservation of capital Index Cumulative real income + Capital returned x Probability of death in each year Starting Balance

17 2.5 How do they compare overall? ABP50 ABP50/25%W ABP50/25%WO ABP50/25%D ABP75 ABP75/25%W ABP75/25%WO ABP75/25%D IA/W Age Pension Capital Personal Income

18 Analysis 1 - $500k account Real lifetime returns are ~2x retirement sum Best value from ABP to 75LE, but dependent on capital return on death Closely followed by ABP 50LE and ABP 75LE + 25% Imm Annuity WCR The lowest value is from the purchase of an Immediate Annuity

19 1.60 How do they compare ex Age Pension ABP50 ABP50/25%W ABP50/25%WO ABP50/25%D ABP75 ABP75/25%W ABP75/25%WO ABP75/25%D IA/W Capital Personal Income

20 Analysis 2 - $500k account Options with deferred purchase of annuity the best value Rating is driven by value of income The lowest value is from the purchase of an Immediate Annuity

21 2.5 How do they compare total income ABP50 ABP50/25%W ABP50/25%WO ABP50/25%D ABP75 ABP75/25%W ABP75/25%WO ABP75/25%D IA/W Age Pension Personal Income

22 Analysis 3 - $500k account Very little differences Basic ABP 50LE provides the best value Very closely followed by ABP 50 LE with deferred purchase annuities Immediate Annuity produces the lowest income value

23 Results for lower and higher sums We will not present all the options again for each case We will analyse the value of all the options

24 $100k: 50LE ABP

25 $100k: 50LE ABP + 25% IA WOCR Def Buy

26 $100k: 75LE ABP

27 $100k: 75LE ABP + 25% IA WOCR Def Buy

28 $100k: Imm Annuity

29 How do they compare? ABP50 ABP50/25%W ABP50/25%WO ABP50/25%D ABP75 ABP75/25%W ABP75/25%WO ABP75/25%D IA/W Age Pension Capital Personal Income

30 Analysis 1 - $100k Again very little differences because primary value is from Age Pension ABP 50LE with deferred purchase annuity is best value best income ABP 75LE with deferred purchase annuity is close second Immediate Annuity produces the lowest income value

31 $1m: 50LE ABP

32 $1m: 50LE ABP + 25% IA WOCR Def Buy

33 $1m: 75LE ABP

34 $1m: 75LE ABP + 25% IA WOCR Def Buy

35 $1m: Imm Annuity

36 How do they compare? ABP50 ABP50/25%W ABP50/25%WO ABP50/25%D ABP75 ABP75/25%W ABP75/25%WO ABP75/25%D IA/W Age Pension Capital Personal Income

37 Analysis 1 - $1m The rankings are here driven by the value of the personal products ABP 50LE with deferred purchase annuity is best value best income ABP 75LE is close second with ABP 50LE third Immediate Annuity produces the lowest income value The changes to the Means Test will make the intrinsic product value more important

38 1.75 Comparison without Age Pension ABP50 ABP50/25%W ABP50/25%WO ABP50/25%D ABP75 ABP75/25%W ABP75/25%WO ABP75/25%D IA/W Capital Personal Income

39 Analysis 2 - $1m Without the Age Pension ABPs with deferred purchase of annuities provide the best value Rankings driven by high income component Immediate Annuities provide much lower value

40 Summary The best outcome varies by amount $100k: ABP 50 LE + Def Buy; ABP 75LE $500k: ABP 75LE; ABP 50LE $1m: ABP 50 LE + Def Buy; ABP 75LE Where Age Pension interaction is set, an ABP with deferred purchase of annuities is the best option More complex in between

41 Summary Options with deferred annuity purchase provide best income value The overall winner is ABP 50LE + deferred purchase of annuities

42 Value of Annuities The preceding analysis has shown Immediate Annuities providing the lowest overall value for income and capital return Why should this be Lets us consider whether it is possible to beat an annuity using an ABP

43 Example Invest in a well balanced, growth oriented ABP Manage cash flows to maintain stability of income Draw an income equal to that provided by a CPI linked annuity with capital return How long will the money last?

44 How long will money last

45 Mortality pooling Participate in mortality swap for 25% of asset value 25% forfeited on death Cannot be withdrawn Pooled receipts (minus costs) distributed in proportion to assets at risk and qx/px Don t need to pool assets separately

46 How long will money last

47 Conclusions Investing in ABP s with the aim of converting some assets to annuities is the best option with current products Investing in ABP s with mortality pooling is probably the better outcome for the future once the products are in place

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