With interest rates at record lows and little chance of a change in sight, creating a reliable income in retirement can be challenging.
With the cash rate at just 2% since June 2015, Australian interest rates are lower than ever before. And according to the Commonwealth Bank economics team, there’s little prospect of rates lifting before the end of 2016.
That’s a problem for investors looking for a secure and reliable income in retirement, without putting their money at risk.
The good news is that there are alternatives. Here are five options to consider, with some of the pros and cons of each.
Option 1. Account based pension
An account based pension is a superannuation account that pays a regular income, with the freedom to choose your own investment strategy.
PROS: You can choose between investment options and set your own pension payment amount (within government rules). You can also adjust your pension payment in response to your changing needs and your account’s investment performance. You can even make lump sum withdrawals when you need them (a limit may apply). And if you’re 60 or over, you usually won’t have to pay any tax on your pension payments.
CONS: Your income isn’t guaranteed — so if your investments don’t perform, you could earn less than you’d planned.
Option 2. Annuity
Available from insurance companies and superannuation funds, annuities give you a fixed, regular income for a set period of time or the rest of your life, depending on the product that you chose.
PROS: You enjoy the security of a pre-defined income, no matter how markets perform. And you generally won’t need to pay tax on your annuity income after you turn 60.
CONS: You don’t have the flexibility to withdraw a lump sum if you need extra cash, and you won’t get to choose where your money is invested.
Option 3. Bonds
A bond works a little bit like a loan. When you buy a bond, you are effectively lending money to the issuer — usually a government or a company. In return, they generally pay you a regular income until the bond matures, at either a fixed or a floating rate. When the bond matures, you get a payout at the bond’s face value.
PROS: Depending on the investment you choose, a bond can offer a higher level of income than cash, with less risk than alternatives like shares or property.
CONS: In Australia, most bonds can be difficult for individual investors to access, which is why many investors choose to invest through a managed fund or super fund. And bonds are not risk free, particularly higher-yielding company bonds.
Option 4. High yield shares
As at 27 October 2015, CommSec data showed that 21 of Australia’s largest companies offered dividend yields of 5% or more, covering sectors as diverse as banking, resources, infrastructure, telecommunications and more. For those looking to earn an income, recent market falls could offer the opportunity to pick up high-yielding stocks at lower prices.
PROS: Carefully selected shares can offer comparatively high levels of income, with the added bonus of franking credits — which are like a tax credit for tax the company has already paid on your behalf.
CONS: Unfortunately, higher returns tend to involve higher risk, and shares tend to be more volatile than other investment options. And while a regular dividend income can help to offset the impact of any future share price falls, there is also no guarantee that a company will continue to pay dividends at the same rate.
Option 5. Property
Residential property is a very popular choice for those looking for a secure, income-generating asset.
PROS: Property offers the potential for rental income today and capital gains in the future. And a buoyant housing market has made property a rewarding investment for many.
CONS: Rising property values have driven rental yields to record lows in many parts of Australia, with the national average yield falling to just 3.3% in August 2015, according to the CoreLogic RP Data Home Value Index. Remember too that house prices can and do fall, especially after a period of strong gains.
Getting the balance right
Not sure which option to choose? The good news is that you don’t have stick to just one. A financial adviser can help you build a portfolio of investments both inside and outside super, with the right mix for your individual income needs and preferred level of risk. That could help you avoid the greatest risk of all — running out of money in retirement.
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