Spreading away from property

By MARY HOLM

Q: My parents both turn 68 this year and are reviewing their investment portfolio.

Can you offer some advice on how their assets should be spread?

For the sake of argument let's assume they have a total portfolio of $1 million. This includes a home worth $300,000 and a direct investment in commercial property valued at $200,000.

I would also like to encourage one of them to buy an inflation-linked annuity when they turn 70, enough to cover their regular costs with their superannuation. Let's say they would get about $2000 a month.

The income from their remaining investments could be used to pay for extras such as holidays.

Can you give some examples of what an inflation-linked annuity, guaranteed for 10 years, would cost for a 70-year-old woman (assuming Mum gets the annuity)?

First, let's tell other readers what we're talking about.

Annuities are the same as pensions. When you buy an annuity, you give an insurance company a lump sum. It then promises to give you monthly payments until you die.

If you die soon, the insurance company does well. If you live for many more years, you're the winner.

One negative is that the money isn't available for heirs. In your case, as a probable heir, you're being big-hearted by suggesting an annuity for your parents.

On the other hand, an annuity can give you peace of mind. You know that however long your parents live, they won't run out of money - and perhaps become dependent on you.

What's more, by getting a 10-year guarantee, as you suggest, your family won't feel ripped off if your mother should die within 10 years of the annuity purchase.

If that happens, the money will be paid to her estate until the 10 years is up.

You say you would also like an inflation-linked annuity. No New Zealand company offers exactly that. They're worried that inflation might soar, and they'd be caught having to make rapidly-rising payments.

They will, though, increase your payments by a specified percentage each year.

You might, for instance, ask for payments to rise 2 per cent a year. If inflation proves to be higher, at least your income will rise a bit, to partly offset it.

Both the 10-year guarantee and the inflation allowance will, of course, cost you.

Either you will pay more for the annuity or, if you have a given lump sum, your monthly payments will be lower.

So let's look at some numbers, gathered by Darrell Calmer-Williams, of Aon Consulting. All the examples are for an annuity with a 10-year guarantee. Payments start at $2000 a month, but rise each year.

* For a 70-year-old woman, an annuity that rises 2 per cent a year would cost about $370,000.

* At 3 per cent a year, it would cost about $403,000.

It is often better for a couple to get a joint annuity. Payments usually reduce by a specified amount after the first spouse dies. In these examples, they drop by 25 per cent.

* For a husband and wife, both 70, an annuity that rises 2 per cent a year would cost about $400,000.

* At 3 per cent a year, it would cost about $439,000.

These are all current annuity prices. They vary depending on insurance company expectations of future returns.

Some experts say cost too much in New Zealand, perhaps because too few people buy them.

But an annuity gives the buyer more certainty than any other financial product. And that's a big plus for many retired people.

Still, if your parents feel that the above examples would take up too much of their $500,000, they could modify their plans.

If they sought a starting income of $1500 a month rather than $2000, the annuity prices would drop proportionately, by about 25 per cent.

You also ask for advice on how your parents' assets should be spread.

They've got half their assets in property, which seems rather unbalanced. On the other hand, commercial property operates in a rather different market from homes.

Still, it would be good to assess your parents' commercial property. Make sure it is offering as much, particularly in continuing income, as alternatives.

Beyond that, your folks might be left with around $100,000 to $200,000 after buying the annuity.

What should they do with that?

If their health is fairly sound, there's a good chance that at least one of them will live past 80.

So perhaps a third or a quarter of their money could go into a share fund, with the idea that it won't be used for 10 years or so.

The value of that investment will fluctuate and sometimes fall. If that would worry them too much, they should give it a miss.

But over 10 years or more, a share or share fund investment is likely to grow more than alternatives. And it's good diversification away from property.

The rest of their money, for use in the shorter term, should go into fixed interest investments. If they are conservative, they could stick with bank term deposits. Otherwise, some could go into high-quality corporate bonds.


* Mary Holm is a freelance journalist and author of Investing Made Simple. Send questions for her to Money Matters, Business Herald, PO Box 32, Auckland; or e-mail: maryh@pl.net. Letters should not exceed 200 words. We won't publish your name, but please provide it and a (preferably daytime) phone number. Sorry, but Mary cannot answer all questions, correspond directly with readers, or give financial advice outside the column.