An annuity gives you a guaranteed income for a set period of time, or the rest of your life. It’s one way to give yourself some certainty about your retirement income.
What is an annuity?
An annuity is a financial product that you can buy using your super or other savings from a life insurance company or friendly society. You pay a lump sum of money in return for a guaranteed amount of income, for a set amount of time.
When you buy an annuity, you choose whether you want the income payments to last for:
- a fixed number of years, or
- the rest of your life
How much you use to purchase your annuity, the amount of time the payments will last for, as well as the other product features you choose, will determine the amount of regular income you get.
Annuities that make payments for the rest of your life (sometimes called ‘lifetime annuities’) are a type of lifetime income stream. We’ve covered lifetime income streams more broadly here.
Features of an annuity
In addition to how long the payments will last, there are other product features you may be able to choose. Keep in mind the product features and conditions of every annuity product may be slightly different so it’s important to compare products before you buy.
How the regular payment is calculated
With a conventional annuity, you decide the payment amount you receive at the time you buy it and it's based on factors such as how much money you used to buy the annuity, how long it’s invested for, and how frequently you choose to receive payments. Your annuity income can increase each year by a fixed percentage or be indexed with inflation.
Some annuity products offer investment-linked payments. For an investment-linked annuity, your regular income will go up or down depending on the performance of your chosen investment option. So, while the duration of your income payments will be guaranteed, the amount that you get is not guaranteed.
Most annuities let you choose to receive monthly, quarterly, half-yearly or yearly payments. You need to agree on the payment terms at the time of buying the annuity. There is rarely flexibility to change these terms after purchase.
Joint or individual annuity
You can use savings to buy an annuity in joint names. If you or your partner dies, the survivor has ownership and access to the funds. A joint annuity also allows income splitting for tax purposes between partners. This may offer a tax advantage if one person has a lower marginal tax rate.
If you use your superannuation money to buy an annuity, the annuity can only be in the name of the person who 'owns' the super.
Your annuity if you die
If you die, payments from an annuity usually stop unless you nominated a reversionary beneficiary or chose a guaranteed period option when you bought the annuity.
- Reversionary beneficiary — Your nominated beneficiary (usually your partner or a dependant) will get your income payments for the rest of their life. This is usually at a reduced level, for example, 60% of your income stream.
- Guaranteed period — A minimum payment period is set when you buy the annuity. If you die, your beneficiary will get your payments, either as a lump sum or income stream. Unlike an annuity with a reversionary beneficiary, the income payments will not reduce.
An annuity forms part of the income and assets tests to determine your eligibility for the Age Pension.
A Services Australia Financial Information Service (FIS) officer can help you work out how an annuity will affect your Age Pension entitlement.
Pros and cons of an annuity
Consider the pros and cons to decide if an annuity is right for you. Get financial advice from a licensed financial adviser or your super fund if you need more information.
Pros
- A regular income for a fixed period of time, or for the rest of your life. Payments from a lifetime annuity will last as long as you do.
- Conventional annuities provide a guaranteed income stream where payment amounts aren’t affected by market performance. This might be suitable for someone who doesn't want to bear investment risk.
- Investment-linked annuities and conventional annuities with indexed payments can help protect you from the rising cost of living, through payments which increase over time.
- If you nominate a reversionary beneficiary, that person will continue to receive some income after you die.
- If you choose a fixed-term guarantee period, your beneficiaries will get some money if you die during that period.
- Life annuities can increase your access to the Age Pension because of more favourable treatment under the income and assets test.
Cons
- When you buy an annuity with a lump sum of money, you give up the opportunity to invest or spend that lump sum yourself.
- Income payments from an annuity may be lower than the returns from investing the lump sum of money used to buy the annuity yourself. This is more likely to happen when you buy a conventional annuity during a period with low interest rates. Lower payments under an annuity are a trade-off for receiving guaranteed income.
- You can't change the terms of payments once the cooling off period is over. In most cases, you cannot withdraw your money as a lump sum (some allow withdrawals under limited circumstances, but significant penalties may apply).
- Your payments might not keep up with inflation, unless you have an annuity that makes payments which sufficiently increase over time.
The difference between an annuity and an account-based pension
Where an annuity has guaranteed payments for a set period, or for your life, an account-based pension does not. Instead, it has more flexibility.
An account-based pension (sometimes called an ‘allocated pension’) is a regular income stream bought with a lump sum of money from your super when you retire. Typically, you get to choose how you want the money in your account-based pension invested
With an account-based pension the government sets a minimum amount you need to take in payments each year. You can also take out any amount you like above that.
An account-based pension gives you the flexibility to change your income amount (as long as it’s more than the minimum, take out ad hoc lump sums, and close the account completely if you want to.
The investment performance of your money in an account-based pension will depend what it’s invested in, and generally your super fund will give you a number of different investment options to choose.
Using a mix of retirement income options
You don't have to take an all or nothing approach to your retirement income. You may benefit from a mix of options. Read our summary of retirement income sources.
Consider your personal needs and circumstances before making a decision. Your super fund, a licensed financial adviser or a Financial Information Service (FIS) officer can help.
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