When Aussies think about retirement income products, annuities may not be the first thing that comes to mind.
But annuities have long been used by Australians and their popularity has jumped dramatically in recent years as retirees grapple with the triple whammy of increased longevity, uncertain financial markets, and the rising cost of living.
Bill Meehan, Financial Advice Specialist at FIS Wealth says outliving your savings is a common concern for pre-retirees and people already retired.
“Annuities can be useful in alleviating some of those worries, because you know exactly how much money you’ll have coming in, and you have the option to add protection against inflation too,” Meehan says.
Here’s a straightforward explanation of annuities, including their key pluses and minuses.
What’s an annuity?
An annuity is a financial investment that in return for a lump sum provides you with a series of secure payments – monthly, quarterly, half-yearly or yearly – either for a fixed term or the rest of your life.
Wait, there’s more than one type of annuity?
Fixed-term annuities have a start and end date. The term of the annuity can range from one year to 50 years. You can choose to have your lump sum returned to you at the end of the term, or gradually as part of your regular payments.
Lifetime annuities, meanwhile, provide payments for the rest of your life, or for the life of a second person after you pass away.
For the purpose of this article, we will focus on a lifetime annuity.
How are your regular payments worked out?
The amount of your regular payments will depend on several factors including: the options chosen, prevailing market rates, your age, gender, and the size of your initial investment. Payments are set at the time of your investment and are guaranteed. They could increase over time with indexation if you choose this option.
How much money do I have to invest?
Most annuity providers require a minimum investment of $10,000, and there is generally no upper limit on the amount you can invest.
Meehan says his clients tend to invest 25-30 percent of their superannuation balance in an annuity, then keep the rest invested in a balance of defensive and growth assets.
“For many of my clients, I have recommended they use the guaranteed payments from an annuity to cover their essential expenses above and beyond any Age Pension entitlements,” Meehan says.
The benefits of an investment in a lifetime annuity
Annuities can protect your retirement income from the rising cost of living, share market turbulence, and the possibility of outliving your retirement savings.
Because your payments aren’t impacted by share market fluctuations, you have certainty on your level of income for life regardless of how long you live.
- Concessional tax treatment
Annuity payments are generally tax-free if you purchase the annuity with superannuation money after the age of 60. Where you purchase an annuity with non-superannuation money, part of the payments may be included in your assessable income and subject to tax.
When you buy a lifetime annuity, you can choose to have payments continue to be paid to your spouse when you die.
As part of the options when you purchase a lifetime annuity, you can also pre-set a time period that should you pass away within, a lump sum payment may be made to your beneficiary or estate.
Your annuity provider generally won’t charge fees for managing your lump sum as the costs of running the annuity are taken into account when your payments are determined.
- The guarantee of the provider
Annuity providers are regulated under the Life Insurance Act 1995, which governs the provision of annuities in Australia. Under this Act, annuity providers are subject to prudential regulation by the Australian Prudential Regulation Authority (APRA) to help ensure they are able to meet their obligations to investors, and must hold a minimum level of capital in the statutory fund.
There are strict policies and plans in place to make sure the capital in the statutory fund stays above the APRA-required amount, so current and future payments can always be met.
What about the downsides?
- Potentially lower returns
Your payments may be lower than the income you could have received if you’d invested your money in other potentially higher growth, higher risk assets such as shares.
That’s because the annuity provider takes on the risk of future market conditions and generally invests in lower-risk assets.
But an annuity isn’t all about the returns. Annuities form part of the defensive assets in a retirement portfolio which guarantees you income no matter what’s happening in the market.
- You may get less money back if you withdraw
Lifetime annuities are designed to be long term investments. Depending on the options you choose when you purchase the annuity, you may be able to withdraw a lump sum within a period selected by you and your financial adviser. This lump sum may be a guaranteed amount, or it may have a decreasing value over time (meaning that if you withdraw, you may get back less than your original investment).
- Value of payments over time
Inflation may reduce the purchasing power of your payments over time. However, some annuities allow you to index your payments to keep pace with inflation.
Have you considered an annuity as a retirement income solution?