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Annuities are an easy way to convert your retirement savings or investment capital into a regular income stream to help pay for your retirement.
They can give you peace of mind in retirement, as they provide a guaranteed income you can use to cover your regular expenses like rates and insurance. Some retirees use annuities to complement other sources of retirement income such as the Age Pension and/or a superannuation account-based pension.
Check out SuperGuide’s simple explainer on how annuities work and the key rules you need to know.
What are annuities?
Annuities have been around a long time. In fact, the idea of paying out a stream of income to an individual dates back to the Roman Empire. Despite this long history, annuities are an often overlooked financial product for creating a source of income in retirement.
Depending on the type of annuity you purchase, they provide guaranteed regular payments for either the fixed term you select, or for the rest of your life.
Indeed, one of the key attractions of annuities is they provide a guaranteed income, regardless of how investment markets are performing. The payment you receive is locked in when you purchase the annuity and remains the same regardless of what happens with investment returns.
If you like the idea of receiving a regular pay cheque in return for investing a lump sum during your retirement, an annuity could be a sensible choice to explore.
How do annuities work?
There are two main types of annuities:
1. Lifetime annuity
You receive a regular payment for your entire life, regardless of how long you live. This can be appealing if you are in good health and your family tends to live a long time.
Most lifetime annuities also offer the option to choose a guaranteed period.This means if you die during the guarantee period, the balance of your annuity is paid to your estate.
2. Term certain (or fixed term) annuity
With this type of annuity, you receive a regular payment for a specific term or time period.
Term certain annuities are usually available for a period from 10 to 25 years and are guaranteed to continue paying you for the time period you select.
Some life companies also offer a deferred annuity. These products allow you to buy the annuity product but not receive your payments until several years after an agreed deferral period.
Annuities are assessable under the Age Pension income and assets tests and this may affect the amount you are eligible to receive in Age Pension payments.
Annuities and your super savings
You can buy an annuity with either your super savings or non-super money (such as the proceeds from an inheritance or property sale).
If you use your super savings to buy an annuity, you receive the same tax concessions as in the super system. This means once you reach age 60, your income payments are tax free and non-assessable.
When an annuity is purchased with non-super money, any payments regarded as a return of your capital are not taxable or assessable for Services Australia purposes.
What happens to my annuity if I die?
When you take out an annuity, you can have a choice about what happens to your annuity on your death. You can select:
1. Reversionary beneficiary
Your nominated beneficiary receives your income payments until their death, although this is usually at a reduced level (such as 60%).
If the annuity was purchased with super money, the reversionary beneficiary must be a dependent person under super law.
2. Guaranteed period
Your nominated beneficiary receives your payments (either as a lump sum or an income stream) for a set period you select when you buy the annuity.
Unlike the reversionary beneficiary option, the income payments received under a guaranteed period are not reduced and are only paid for the guaranteed period.
Annuities can be purchased in either single or joint names. If you buy an annuity in a joint name with your partner, it’s possible to split the income you both receive, which may have tax benefits.
With a joint annuity, when one partner dies, the survivor becomes the owner of the annuity and has access to the money either as an income stream or a lump sum.
Pros and cons of annuities
|Guaranteed income regardless of moves in investments markets||You may be able to achieve higher returns outside an annuity, although this may involve more risk|
|Income for the rest of your life (if you choose a lifetime option), regardless of how long you live||No control over how the money is invested|
|Returns are based on the average life expectancy so if you live longer than the average person you’ll receive more in total payments||It may not be possible to transfer your money out of the annuity contract|
|From age 60, annuities purchased using super money are tax free||After your death, any money left may not be payable to your dependents or family|
|Annuities can be used to supplement other retirement income streams (such as account-based pensions)||With a long-term annuity, your purchasing power is reduced over time due to the impact of inflation|
|Income payments can be indexed to increase each year to combat the impact of inflation||You may lose a percentage of your money if you cancel the annuity or withdraw your money before the end of its term|
|Investment earnings are tax free||Less flexible than an account-based pension|
|Provide a known cash flow to cover essential expenses so you can feel more comfortable with discretionary spending decisions|
|May provide an increase in your Age Pension entitlement|
Income from your annuity
The income you receive from an annuity is set when you buy the annuity and does not change over time. Your payments can be received monthly, quarterly, every six months or annually – the decision is up to you.
Buyers can also choose to protect their income payments against inflation by paying an additional fee to have the payments indexed each year, either by a fixed percentage or in line with inflation.
Your actual income payment depends on a number of factors, such as how much money you are prepared to pay towards the annuity and the rate the annuity provider is currently offering. This is normally based on complex actuarial calculations covering things like your predicted lifespan, the options you have selected for your annuity and the outlook for investment market returns.
How does an annuity differ from an account-based pension?
An account-based (or allocated) pension provides you with a regular income stream from your super savings in retirement. To invest in an account-based pension, you must have reached your preservation age or met a condition of release for your super.
With an account-based pension, your savings are invested in a range of asset classes such as shares and bonds. Although this provides potential for growth and higher investment returns, it also adds risk and your savings may run out before you die.
Annuities, on the other hand, are not affected by the performance of investment markets. You are guaranteed to receive set regular payments throughout the life of your annuity.
Account-based pensions also offer the flexibility to vary your payments at any time (provided they meet the required annual minimum percentage withdrawal) and to make a partial lump sum withdrawal. Annuities don’t offer this flexibility, which is why many retirees select account-based pensions for the majority of their retirement savings.
Annuities and the Age Pension
Eligibility for the Age Pension is determined by both your age and an assessment under the Age Pension income and assets tests.
The account balance of an annuity is considered an asset for the Age Pension assets test, with payments from the annuity being assessed under the Age Pension income test.
Prior to 1 July 2019, the entire account balance and gross income (less any return of capital to you) were assessed if you purchased a lifetime annuity (not a term annuity).
For lifetime annuities commenced after 30 June 2019, new Age Pension assessment rules apply. Under these changes:
- 60% of the purchase price of a lifetime annuity is assessed under the assets test until you reach age 84 (subject to a five-year minimum)
- 30% of the purchase price is then assessed from age 85.
Under the new rules, only 60% of the payments you receive from a lifetime annuity are assessed under the income test.
Are annuities a good idea?
For some retirees, annuities can be a valuable strategy to consider when developing your retirement income plan.
They provide a source of diversification for your retirement income, while also minimising the risk of outliving your savings and having insufficient income to fund your life after work.
Although they have many benefits, annuities are not appropriate in every situation, so it’s important to seek professional advice about their suitability for your particular financial circumstances and goals before you purchase one.