A guaranteed income in retirement sounds terrific doesn’t it? You don’t need to keep working and the money rolls in every month. That might sound like a pipe dream for many people but it is actually the reality for most Australians. The reason for this is the Age Pension is a guaranteed income stream that the majority of Australians are able to access when they reach Age Pension age. It’s not a lot of money, but it is reliable and guaranteed by the Government. And despite all our respective views on how trustworthy various governments are, the Age Pension has always been supported and will continue to be supported by all the major parties.
For many people the Age Pension is not enough and for those that have additional savings or investments a common question is how to generate a guaranteed income from those investments. The answer could be an annuity.
What is an annuity?
An annuity is a type of financial product that makes a stream of payments over a period of time. The Age Pension could be considered to be an annuity, although it is a Government service rather than a financial product. Annuities are typically provided or guaranteed by insurance companies.
There are different sorts of annuities that are designed to meet the needs of different people. Here are three common types.
Term annuity
A term annuity provides a regular guaranteed income for a fixed period of time that you choose. It could range from one to 50 years. How much you get in the regular payments depends upon how much you invest at the start.
Lifetime annuity
A lifetime annuity provides a guaranteed regular income for the rest of your life. This takes away a lot of the fear many people have of running out of money. Similar to the term annuity, how much you get will depend on how much you invest. The difference between this and a term annuity is that the payments don’t stop, they last as long as you do, even if you live to 120!!!
Deferred annuity
Many annuity payments start from the time of purchase but you can also defer the start date of the payments e.g. you could buy a lifetime annuity at age 65 but you don’t want the payments to start until you are 75.
Annuities are often combined with other sources of investment income. As an example someone might have a base level of Age Pension, some income from their superannuation – perhaps an Account Based Pension – and then a deferred annuity that might kick in as insurance against a time when their super might run out.
Pros and cons of annuities
As with all forms of retirement income, there are upsides and downsides to annuities. The following is a very brief and general overview, with the caveat that it is important you seek professional financial advice before committing your savings.
Pros
- Guaranteed income for life, or for a fixed term
- Ability to index this income for inflation
- Lifetime annuities will last as long as you do
- Your partner or spouse is income-protected if they are a reversionary beneficiary
- A potential boost to Age Pension entitlements as some of the annuity purchase price can be exempt from the assets test (depending upon the type of annuity purchased)
Cons
- Lack of access to these savings – they are essentially locked up for the duration of the annuity
- Low returns if purchased at a time of low interest rates
- Fixed income may become a downside if better options arise
- You have no control over where your money is invested
- You can pay a lot for a lifetime annuity and pass away soon after. Your estate doesn’t get that money back
Annuities are not for everyone as they can be expensive. That guaranteed income for life does come at a cost. It can be difficult to define the exact cost of an annuity. Fees are often less than explicit. It can also be challenging to understand whether a term, deferred or lifetime annuity will best suit your needs. But this form of additional guaranteed income can also provide some peace of mind and that can be worth a lot.
Understanding more clearly exactly what your retirement income situation could look like helps your decision making. It will allow you to consider if annuities do offer an option that might be worth considering as part of your retirement mix. If you want help understanding your retirement income forecast you can book a consultation with one of our advisers
