Pension phase focus – Protecting your purchasing power

Co-founder of the Switzer Report
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We are not all thrill seekers – and nor should we be. For many retirees, security is a key factor when it comes to investing super monies, as is the need to maintain purchasing power to deal with the impact of inflation and rising prices.

Annuities (term or lifetime) issued by life insurance companies such as Challenger or CommInsure are a popular investment option. Purchased with an upfront payment (which can be from your SMSF), they are straightforward investments offering a regular, reliable payment of income and capital, usually indexed for inflation, and sometimes payable for life. One well-known life insurance company describes the payment as “guaranteed”.

The downside for this “certainty”, “security” and “guarantee” is a low, effective investment return.

An alternative to life insurance annuities is the Waratah Annuity Bond, issued by the NSW Government. Here is our road test.

Waratah annuity bonds

The ‘NSW Waratah Annuity Bond’ is a NSW Government Guaranteed annuity style bond that pays a CPI indexed monthly cash flow for 9 years. For every $100 invested, it pays $1 per month, plus an adjustment for inflation. Over the nine years, this is 108 monthly payments of $1, plus an adjustment for inflation. If inflation averages 3% over the period and $100,000 is invested, the payment starts at just over $1,000 for the first month, and finishes at approximately $1,304 in month 108.

Each payment represents a return of capital and interest, and an amount paid as a result of increases in the CPI. As the principal is repaid over the term of the bond, the interest component of each payment decreases and the principal component increases. This is shown in the diagram below.

Features of Series 7

NSW TCorp (the NSW Government’s borrowing agency) is currently issuing its 7th Series of Waratah Annuity Bonds. These have the following features:

With 108 payments of $1 plus an inflation component, and a sum invested of just $100, there is actually a payment of interest on top of the inflation rate. This is described as ‘the base interest rate’ (real interest rate) of 1.72%. When the assumed inflation rate of 3.0% is added in, the effective “interest rate” is 4.77%. Technically, this is known as the ‘internal rate of return’ (IRR) – for broad comparative purposes, you could use this rate to compare it to a bond or other investment opportunity.

Critically, investors will receive the actual inflation (CPI) rate. If inflation averages more than 3% over the period, the IRR will be higher than 4.77%. If inflation averages only 2.0% over the period, then the IRR will be around 3.75%.

There are two other interesting features of the Waratah Annuity Bond. Firstly, holders can’t suffer from deflation or a “negative” CPI measure – it provides protection in that the current month’s payment can’t be less than the previous month’s payment. Also, as the annuity bond commences on a fixed date, investors receive the RBA cash rate of 2.50% on their investment until the annuity bond commences.

How Waratah Annuity Bonds stack up

Waratah Annuity Bonds may suit retirees who require a secure, monthly payment of income that it is indexed for inflation. For example, if you had $1 million in your super fund, you could purchase for $400,000 an indexed monthly income payment of $4,000 ($48,000 pa) for the next nine years, and (potentially) invest the remaining $600,000 in growth or other assets.

And they don’t get too much safer than a NSW Government Guarantee.

While the expected rate of return of 4.77% isn’t flash compared to what you might hope for if taking some risk, it does compare quite favourably to life insurance term annuities. Challenger’s comparable product, a nine year Guaranteed Term Annuity, RCV (residual capital value) zero inflation linked, was quoted for the week ending 27 October at 4.93%.

The Waratah Bond has a much stronger guarantee, is a little more liquid and has some improvement in the application of the CPI – the downside, much less flexible. Whereas with life company annuities, you can nominate the term (from 1 year out to 50 years), take payments monthly, quarterly or annually, and/or consider as an alternative a lifetime annuity, the Waratah Bond only has a term of nine years. In time perhaps, they will introduce a series with a longer term.

Bottom line – within the constraints of the bond, a strong alternative to life company annuities. Applications can be made directly to NSW TCorp, through this website.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.

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