Layered approach for retirement income

Life expectancy is on the rise
With around 700 Australians retiring each day and life expectancy on the rise, the need to provide for a longer retirement has become more critical than ever. Taking into account improved mortality rates, a 65 year old male today can expect to live an additional 22 years, to the age of 87, according to the Australian Government Actuary. But with longer life expectancies, comes the need to establish a robust retirement plan that will ensure you receive a secure and reliable income to last for the rest of your life.

Income in retirement can come from many different sources, and indeed, the more of a spread of income streams you have, the greater chance you have of being able to manage when one doesn’t deliver as you had expected.

Consider using a combination of products that provide the necessary income to cover the different types of expenses you’ll face in retirement. There are products that fluctuate in their returns, such as account-based pensions and shares, and these can be used to cover discretionary spending. Whereas income streams, such as annuities and the Age Pension, offer a more certain level of income for a defined period of time or for life and can be used to cover everyday costs.

The best mix of income streams obviously depends on your own individual circumstances and retirement goals, so seeking professional financial advice is the first step.

While most people may look to their own savings, account-based pensions and shares as their main sources of retirement income, consideration should also be given to annuities and how they could provide a stable source of income in retirement. Annuities are a reliable option for retirees looking for a secure financial investment that pays a guaranteed, regular income over a fixed term or for life.

Retirement planning with layered income
While superannuation may be a major source of income in retirement for many Australians, a recent YourLifeChoices retirement affordability research shows, only 19 per cent of the 6194 respondents believe their savings would provide a lifetime income.

This calls for a need to create a retirement plan where a combination of investments work together to pay you an income throughout retirement. An income tiered approach is one way to create a structured investment portfolio where income sources are ‘layered’. This means you have a layer of guaranteed income that covers the essential costs of living, while another ‘layer’ is market-linked income funds which can be used to cover discretionary expenses.

So, how does income layering work in real life? Let’s look at Joe and Tina as an example:

Joe and Tina are both 65 years old and planning their retirement.

They have combined retirement savings, including super, of $500,000, personal assets of $20,000 and they have no mortgage to pay. They estimate that they will have ongoing essential expenses of about $39,000 a year in retirement, an amount above the current maximum Age Pension of $34,819 (at 1 July 2017) and significantly above their current Age Pension entitlement of $23,072 a year (based on their current assets and income).

Based on the advice of their financial adviser, Joe and Tina invest $81,110 in a lifetime annuity, providing them with a secure income of $4,618 per year (indexed each year by partial CPI) for the rest of their lives.  This ensures that should their other assets ever run out they will be able to meet their essential expenses with the combination of this income and the maximum Age Pension payable.

However, they want travel to be an important part of how they spend their first 10 years in retirement, as well as dining out and socialising with friends. Therefore, they have set themselves an initial target retirement income of $60,000 per annum.

They decide to invest $312,221 into an account-based pension where they select to draw a yearly payment of $26,310 providing them flexibility and liquidity. 

Their adviser also recommends investing $56,669 in a 10-year term annuity, which will give them $6,000 a year for 10 years.  This is used for funding desirables in this period of ‘peak retirement spend’ including desired expenses such as travel and dining out and other expenses such as home repairs or other unforeseen costs for the next 10 years.

The diagram below shows how this combination of investments is ‘layered’ to provide a secure income in retirement for Joe and Tina. 

This example is provided for illustrative purposes only. It is intended to be general information only and not financial product advice and has been prepared without taking into account any person’s objectives, financial situation or needs. It is strongly recommended that prospective investors seek financial product advice as well as professional taxation and social security advice in relation to their individual circumstances. For full details of how these figures are calculated, refer to Challenger case study for Joe and Tina.

YourLifeChoices Writers
YourLifeChoices Writers
YourLifeChoices' team of writers specialise in content that helps Australian over-50s make better decisions about wealth, health, travel and life. It's all in the name. For 22 years, we've been helping older Australians live their best lives.
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