Opinion
The overlooked tool that can guarantee your retirement income
Dominic Powell
Money EditorReal Money, a free weekly newsletter giving expert tips on how to save, invest and make the most of your money, is sent every Sunday. You’re reading an excerpt − sign up to get the whole newsletter in your inbox.
After a couple of short weeks and a long Easter break, I’m betting many of you are looking at the pile of uneaten chocolate in your kitchen and hoping you’ll never see another foil-wrapped egg again. But before we get too far into April, there’s one more egg you should give some thought to: your nest egg.
If you’re not sure how an annuity works and if it’s right for you, here are some tips.Credit: Michael Howard
Oeuf-ul puns aside, thinking about our income in retirement is something that takes up an increasing amount of brain space as we get older, especially if we start to worry we may not have enough to live on. For most of us, our main source of income once we finish work will be our superannuation, supplemented by the age pension, with perhaps some dividends or rental income.
However, when it comes to retirement income, there’s another option that doesn’t get a lot of airtime – annuities.
Annuities are a fixed income stream financial product where the user is provided with a set guaranteed income over a period of time in return for their investment. For example, you could invest $100,000 for a fixed term (typically between 1 and 50 years) and you would be paid a set amount of interest at a regular interval for the duration of the annuity. At the end of the term, you would receive back the amount you invested. Alternatively, you can draw down on your capital to receive a higher payment.
While set-term annuities are a common option, more popular among retirees are lifetime annuities, which pay you a guaranteed income for as long as you live.
What’s the problem?
Despite the level of concern about having enough money in retirement, annuities are often overlooked by retirees. A Treasury discussion paper from last year revealed just 3.5 per cent of assets held in superannuation pension accounts are in annuities. The paper also noted retirees were “reluctant to purchase annuities”, largely due to a lack of information, their relative lack of flexibility and significant upfront investment.
What you can do about it
If you think an annuity might suit you, or if you’re just curious, here are some things to consider:
- How they work: On hitting retirement, people typically transfer their super out of an accumulation account (where their super guarantee payments and any voluntary contributions have been accumulating) and into a pension account, from which they can withdraw their money tax-free, either as regular fortnightly or monthly payments or as larger lump sums, for as long as the balance lasts. This can pose the challenge of how to make that balance last your lifetime, says Mandy Mannix, chief executive (customer) at major annuity provider Challenger. In contrast, an annuity guarantees you a regular and reliable stream of income. “If inflation surges, as it has in the past three years, or the market falls, retirees can find that the income they take out of the account-based pension buys them much less. And when the money in the account runs out, the income stops,” she says. “Annuities provide certainty with a guaranteed stream of income, no matter how long the retiree lives, and can protect against inflation.” Annuity income is also tax-free as long as you purchase it with your superannuation.
- Who they suit: If you’re someone with a healthy superannuation balance, and you’re relatively confident your nest egg will a) last your lifetime and b) provide enough income for you to live comfortably, an annuity is probably not for you. However, if you worry about the amount of money you’ll have to live on in retirement, an annuity may suit. “Lifetime annuities – particularly those with payments linked to inflation – [can be] great for retirees who want a stable regular income that they can count on, as this gives them the confidence to spend in retirement,” Mannix says. They can also be a good option for those who expect to rely on the age pension at some stage, because …
- Annuities and the age pension: In some circumstances, signing up for an annuity can mean you become eligible for the age pension, or can increase the amount of pension you already get. A change in the rules in 2019 means only 60 per cent of the capital invested in a lifetime annuity is assessed for the pension means test. In contrast, the entire balance of a standard super pension account is assessed. The rules are complex, however, and having an annuity won’t automatically mean higher age pension payments. It’s best to check with a financial planner.
- Things to watch out for: As highlighted in Treasury’s discussion paper, many retirees are wary of annuities, and not without good reason. Money expert Noel Whittaker has described them a few times as an “inflexible investment”, as they generally don’t allow you to access your capital – if for example, you need a lump sum to pay for a renovation or a new car – at least not without paying a fee. Annuities also often pay a lower rate of return on your investment than other market-linked investment products, as the funds are generally invested more conservatively. It’s worth doing the sums to determine if you would be better off keeping your funds in a regular super pension account. Annuities can also pose problems for estate and inheritance planning if you die before their term, though most lifetime annuities these days include “death benefits” which ensure the payments are made to your beneficiaries.
Advice given in this article is general in nature and is not intended to influence readers’ decisions about investing or financial products. They should always seek their own professional advice that takes into account their own personal circumstances before making any financial decisions.