Annuities and your Retirement

There is a type of an income stream, that I have not explained yet… till now, however, based on lots of questions and feedback I receive, it is time to discuss annuities.

I honestly believe there is lots of misconception and misunderstanding about annuities. Just like any other financial instrument, they can work in your favour if you know when it is appropriate to use them to complement other sources of income.

An annuity can work wonders for some and not help others all that much, it all goes back to your income requirements, your investment risk appetite, how you feel about money, what type of income stream you require, is income security of importance for you and your overall financial set up.

So today, I want to explain:

1. What annuities really are? – as I see them being misunderstood and misinterpreted by many
2. How are annuities guaranteed?
3. What types of annuities are available?
4. How do annuities work?
5. Benefits and negatives of annuities

“People always live forever,
when there is an annuity to be paid them” 

Jane Austen

An English writer best known from her novel “Pride and Prejudice”  

And an amazing thing is, that to a degree this quote still correct today. Annuities are what can provide you with an incredible degree of income security and reliability for as long as you choose.  

So let’s jump into our topic of today: 

1. What are annuities?

In a simplest form annuity is a contract between you and the financial institution, which is a life office, that will provide you with a predetermined level of income for an agreed and specified investment term for the specific lumpsum that you invest with that life office. 
The holding institution issues a stream of payments in the future for a specified period of time or for the remainder of your life. 

2. How are annuities guaranteed?

Annuities are a very special form of an income stream, that is subject to restrictions outlined by the Life Insurance Act and regulated by the Australian Prudential Regulations Authority (APRA), who continually monitors investments made by the life office ensuring that the life office can always meet their obligation to you to receive payments as per your annuity contract.

APRA is the authority that regulates the banking, insurance and superannuation industries. 

Life office is required to have a statutory fund  that holds enough capital to withstand any market changes. This is why, even if there is a major market crash, such as the Global Financial Crisis, Covid, or even now Ukrainian war that immediately impacted the world market with uncertainly and volatility, your annuity payments are still made from that statutory fund.  APRA is the body to safeguard all your future payments for life of your annuity.  

3. What types of annuities are available to you?

In Australia these days we have several types of annuities that have been created for a specific reason or a specific outcome such as: 

• Term Annuities
• Lifetime Annuities 
• Annuities that assist with Aged Care  
  

It is important to note that you can invest into an annuity your private money, so your savings from your bank account or your superannuation money, which you do by a rollover of a specified amount from your existing superannuation fund or a pension fund.

4. How annuities work? 

Today we will concentrate on term annuities, and I will prepare a full explanation of the other two annuity types separately.

Term Annuities

They are similar to your usual Term Deposit, but rather than issued by your bank, you set it up via an application to a life office and you can choose the term from 1 year up to even 50 years with income that can be paid monthly, quarterly or annually, with a possibility of income reinvestment at maturity and with your total asset being repaid back to you at the end of the term of your annuity.   

Why would you invest into Term Annuity as opposed to a Term Deposit or a High interest savings account? Well, these days the last option of High Interest savings accounts is just a joke, there is hardly any interest paid  to investors any longer, so I am not even going to bother to compare those.

But when comparing with a Term Deposits:

• Annuities  can often provide a slightly better rate of return over those shorter terms, but obviously you need to check those rates as they change weekly or monthly depending on cash rates at the time of commencement of your investment. 
• the choice of investment term is greater - with term deposit it is usually up to 5 years only but check with your bank
• You can choose to have your regular payments increased in line with CPI, or you can choose the payments to you to include ongoing repayment of your own capital with zero balance at the end of an investment term.
• The big benefit is that you can nominate one or more beneficiaries that will receive your term annuity as a death benefit if you pass away, unlike term deposit or any bank account you set up, where in most cases you have no choice, but your savings will be paid out to your estate. And sometimes there are reasons, why you don’t want a particular pool of funds to be distributed to the estate, but rather avoid Will distribution for that asset.  If this is your situation, you really need a solid financial advice, how to set up your assets from Estate Planning perspective.  

5. Benefits and negatives of annuities:

Benefits: 

• payments are provided to you for the life of the annuity contract
• payments are guaranteed as my previous explanation

You can lose your Age Pension eligibility under Income and Assets test.   

Due to market downturn, your account-based pension can reduce in value dramatically, which will impact the level of your retirement income most likely for the remainder of your retirement. 

But lifetime annuities, once set are guaranteed to provide your income payments for the term set up in your application, regardless of market behaviour, regardless of changes in regulations, this is just about the only true income guarantee you find in Australia. 

• annuity can address the risk of outliving your savings.  
• in specific situations and when set up correctly, annuity can assist with improvement of your Age Pension payments. See: “How to improve income and lifestyle in retirement”.  
• If an annuity is set up with superannuation money, your income payments are tax-free 
• you have a choice of beneficiary, and if annuity is set up with superannuation money, you can even nominate your spouse as a “reversionary beneficiary”. Sometimes it is beneficial, other times not. 
• Generally, annuities have no product fees, so unlike account-based pensions, there is no account fees, investment management fees, administration fees – none of those.  

Negatives of annuities:

• Once set up, they cannot be altered 
• Money is locked away, which can be benefit or a negative, depending on your situation, 
• You cannot make partial withdrawals. There is a predetermined withdrawal period disclosed to you in the quote, and during that period if you need to make a withdrawal, you have to withdraw the full balance and cancel the annuity. 
• Annuities can be complex; therefore, you really need a professional advice how to set them up correctly for your benefit, otherwise you might end up with a product that is not assisting you with reaching your retirement income and assets goals at all. 

Here it is, our first review part 1 of annuities. We will continue exploring other types of annuities in future articles.

By: Katherine Isbrandt CFP®
Money Strategist & Retirement Planner
Principal of About Retirement