Pros and cons of income streams

Noel to the rescue

Few people understand retirement income as well as Noel Whitaker. Today we are examining the pros and cons of Lifetime Income Streams (LIS) and Noel has helped us out with some Q&A on these relatively new products.

But first, some background.

There has been a rapid increase in the number of super funds and financial institutions who offer Lifetime Income Streams. Unsurprisingly, there is also an increase in the uptake of this form of retirement income. Treasury estimates suggest that just 3.5% of super is held in this form of investment. This may not sound high, but individual companies are reporting much higher interest than a few years ago. One of the reasons is that there are more people retiring and converting their super savings into different income streams, so there are a higher number of potential customers. But there has also been a lot of refinement in these offerings – they are much more flexible than those previously offered, so they have gained in appeal as part of a retirement income mix.

Why should you buy?

Lifetime Income Streams are a relatively new form of ‘retirement insurance’ offered in regular, reliable income payments for the rest of your life or a defined period of time.  They have previously been offered by life insurance companies but some superannuation funds are now designing them or offering them as a reseller, using their own brand name.

The advertising for these income streams promises a lot: security, peace of mind, perhaps even a ‘set and forget’ way of paying yourself in retirement. 

But is it really that simple? 
Probably not, is the short answer.

Often promoted as an ideal ‘top up’ to an Age Pension and/or Account-Based Pension (from your super), you’ll need to understand the different tax treatments, and Centrelink rules around not one, but two different extra income streams if you do happen to qualify for an Age Pension. Adding this third stream of income can mean juggling even more calculations. This is not a reason to rule out the purchase of a Lifetime Income Stream as part of your mix, but a cautionary note that you will need to consider many aspects of your earnings before you commit. This is probably one of the reasons that most companies which offer Lifetime Income Streams strongly advise (or insist) that you purchase this product through a licensed financial adviser. Noel agrees that retirees will need the support of a qualified adviser for this major decision.

The following is a brief summary of the main pros and cons of Lifetime Income Streams and next steps for those who believe this product will suit them.

Pros:

• The concept of a defined amount of income for a defined period of time is immensely appealing for people concerned about price rises and market volatility
• Similarly, the sense of security of knowing how much you will earn can go a long way towards nullifying the fear of running out.
• Since 1 July 2019 there has been a ‘discount’ on the amount deemed for the assets and income test for the Age Pension. Until age 84 only 60% of the asset and income of a LIS is counted. After age 84 only 30% of the asset value is counted but the income is fixed at 60%.
• Generally there are tax advantages with a LIS.
• Some LIS are now indexed, which means that they can keep pace with cost-of-living increases
• You will need to nominate a reversionary beneficiary if you wish to pass this income to a family member if you predecease them.  This is a positive but can also make your LIS more expensive – because there are two people involved, (you plus the beneficiary), you could also start with a lower income.

Cons

• LIS and annuities can have complex terms and conditions. There are many ramifications including those of tax, Centrelink rulings, estate planning and pricing so it can be difficult to assess the value of such a product. This is no doubt why most providers will only sell these offerings through approved advisers. While APRA was previously responsible for regulating annuities, the new generation of LIS have a ‘cross agency’ process which involves four regulators (ATO, ASIC, APRA and DSS) which is evidence of the degree of complexity.
• Unlike many other financial products including credit cards, bank accounts and bank loans, it is difficult to make direct comparisons between the different LIS products. That is because they vary in their offerings and conditions, so an ‘apple with apple’ comparison is challenging.
• Pricing again can be difficult to evaluate and compare. Some products claim to have no separate fees, others list them in addition to the price of the LIS. 
• Because these types of products offer a degree of security in exchange for a long-term financial commitment, it can be difficult to withdraw funds except under exceptional circumstances or without a penalty.
• If you purchase your LIS during times of low interest rates your income will be similarly low

What does Noel say?

Comprehensive income products for retirement (CIPRs)

Given that Account-Based Pensions provide no certainty and standard annuities have little flexibility, there has been a push, supported by all major political parties, to design a product that retirees would be happy to use, and that product providers could produce in a cost-effective way. This has led to a newer retirement income product, the Lifetime Income Stream.

Q. Is a Lifetime Income Stream as flexible as an Account-Based Pension?

A. Everything we do in life has upsides and downsides. Account-Based Pensions are totally flexible but also exposed to market forces. The real appeal of a LIS is that it can be worth thousands a year in pension benefits. But you are tying up your money for the rest of your life – or the long-term. Put simply, you are losing access to capital and you will need to be comfortable with that.

Q. How do ordinary retirees understand the detail and compare products

There’s no easy answer here. A lot of these offerings are still under development. It’s one case where you will need to seek qualified advice. And yes, you may have to contact the vendors and ask them to explain costs and benefits and then create a spreadsheet to compare the different products.

Q. Are all LIS indexed?

A. Some are and it’s important for you to consider if this is a feature that is important – but beware, such ‘added extras’ may attract a higher fee or price. Similarly if you nominate a reversionary beneficiary, you probably won’t get as much money from the start.

The final word from Noel

I have a chapter on Lifetime Income Streams in the most recent edition of Retirement Made Simple. There are benefits to both an ABP and a LIS – The Account-Based Pension provides the flexibility — the Lifetime Income Stream the certainty. 

Further detail on Age Pension rules for Lifetime Income Streams can be found here.

Retirement Essentials can also help you to better understand your current or planned retirement income or how to manage your super in retirement. If you are interested in reading more about lifetime income streams you can also read our article Lifetime income streams: Do they guarantee money for life?