4 October 2017

Question of the week

"A guaranteed income for life sounds too good to be true. What's the catch?"

A guaranteed income for life. It's a strong claim and for some, it's hard to believe.

In reality there's nothing magical about it. It's just a combination of investment and insurance.

Lifetime invests your savings in a balanced fund and insures your income.

The balanced fund is invested with four large investment managers (Vanguard, ANZ, NZX, and Harbour Asset Management) who in turn invest in high quality stocks and bonds in New Zealand and around the world. 

All your investment returns from the balanced fund are credited to your investment account and your income, fees, and tax are debited from your account.

In years where your investment returns are less than your income plus fees plus tax, some of your capital is used to make sure your fortnightly income is always constant. If over the course of your retirement you eventually drawdown your capital, Lifetime’s insurance pays your income until you pass away.

Our retirement income calculator lets you see your expected account balance at any given age in time. Just scroll down the page and hover your mouse over the pink line on the graph.

For example, let's pretend you're 65 years old and have invested $100,000 with Lifetime.

At 65, your income rate is 5.00% per annum after fees and tax, giving you a net income of $5,000 each year, paid into your bank account at a rate of $192.31 every fortnight, for life.

  • In 5 years time, you would have received $25,000 of income payments ($5,000*5) and your account balance is expected to be $88,500.
  • In 10 years time, you would have received $50,000 of income payments ($5,000*10) and your account balance is expected to be $74,142.
  • In 20 years time, you would have received $100,000 of income payments ($5,000*20) and your account balance is expected to be $33,841.

Once your account balance declines to zero Lifetime's insurance continues paying you $5,000 every year for the rest of your life.

If you pass away before this date, your entire account balance will be paid to your estate. You can also choose to withdraw part or all of your account balance down the track for any reason. No withdrawal fees apply.

So the only 'catch' of your guaranteed income for life is that your regular payments are a combination of investment returns and you using some of your own capital. 

However this can't really be described as a 'catch' at all. If you were to invest your $100,000 in a term deposit paying gross 3.50% per annum (2.89% per annum after tax) and draw down $5,000 every year, you would have to use your own capital to achieve this. Sooner or later you would use up your capital and your income would stop.

Alternatively, you could put your money with a managed fund and instruct your manager to drawdown $5,000 per annum for you to spend. Managed funds generally provide higher returns than term deposits but are more volatile. Managed funds typically have negative returns 1 in every 5 years. Drawing down an income in years with negative returns accelerates the reduction of your capital.

What Lifetime gives you is certainty. You know you have a regular payment coming in every fortnight for the rest of your life, regardless of what happens to markets or interest rates during your retirement. It’s designed to help you top up the money you get from NZ Super to meet you regular living expenses.

Like all investments, diversification is key and Lifetime works best in conjunction with other assets. It can be helpful to keep some money in the bank for emergencies, healthcare, holidays etc. If you have money that you don’t need in the short term, putting some money in a managed fund can also be effective.

What could your retirement income be?