The global financial crisis (GFC) has led to many retirees experiencing substantial declines in the value of their retirement savings. Members of self managed super funds (SMSFs) in pension phase, in particular, have been hard hit with many having to sell assets in times of market downturn and forced to realise capital losses in order to meet pension requirements.

A strategy that is often overlooked is the use of an annuity as part of the SMSF's investment portfolio. An SMSF can buy an annuity with a nil residual capital value (RCV) to cover pension payments for a period of time, say seven to ten years, with its remaining assets invested in more growth-oriented assets over a longer timeframe.

This strategy allows growth assets to remain intact and allows them the ability to recover when markets are volatile. Meanwhile, the member can rest assured that their pension payments are guaranteed over the selected term regardless of market conditions.

Some factors to consider when deciding the appropriate term for the annuity and how much to invest are:

• the timeframe over which an investor would like to secure their pension payments

• whether the annuity is to cover all or only part of the pension payments

• the client's risk profile.

Annuities generally provide a highly competitive return versus investments with a similar risk profile. Challenger's Life Company, through which annuities are offered, can offer an attractive return to investors as it invests both the amount used to purchase the annuity, as well as the additional amount of capital Challenger has to support the guarantee, in a range of high quality assets.

Case study:

Jack (65) has recently started an account-based pension in his SMSF with a balance of $700,000. He requires annual income of $45,000 (although the minimum payment is currently only $26,250). He has property and other investments outside his SMSF.

Jack decides that the fund should buy an annuity to cover his cash flow needs for the next seven years. He wants to be certain that he will not have to sell down shares or units in managed funds to make the minimum pension payments in that seven-year period.

The fund buys a seven year nil RCV, 3% indexed annuity* for $263,000. The annuity has annual payments of $45,131 (representing a nominal rate of 5.35% p.a.) in the first year which covers Jack's required amount.

He selects a 3% indexed annuity to cover potential increases to the minimum requirement over the next seven years. With his cash flow needs covered for the next seven years, Jack is much more comfortable with the remaining assets in the SMSF being invested in more growth-oriented investments.

If you'd like to know more, please contact Chris Flook , KMW Wealth Solutions Financial Planner on Ph: 3275 7400 or chrisflook@kmwaccountants.com

Reference: Challenger's Life Company has given permission for KMW to use this article.