An annuity gives you a guaranteed income for a set period of time, or the rest of your life.
An annuity is less flexible than an account-based pension, but you have greater certainty about your future income.
How an annuity works
You can use your super or savings to buy an annuity.
When you buy an annuity, you choose whether you want the payments to last for:
- a fixed number of years, or
- the rest of your life
Preservation age
If you are using super money to buy an annuity you must have reached preservation age and meet a condition of release, such as permanently retiring.
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 has a lower marginal tax rate.
If you use your super to buy an annuity, the annuity can only be in the name of the person who 'owns' the super.
Income from an annuity
For a conventional annuity, you decide the payment amount you receive at the time you buy it. Your annuity income can increase each year by a fixed percentage or indexed with inflation.
For an investment-linked annuity, your annuity income will vary depending on investment performance. You can normally choose how the annuity provider invests the funds used to purchase it.
You need to also agree on the payment terms at the time of buying the annuity. There is rarely flexibility to change these terms after purchase.
You can choose to be paid monthly, quarterly, half-yearly or yearly.
An annuity bought with super money must pay you a certain percentage of the balance, based on your age. The Australian Taxation Office website has more information about minimum annual payments.
Your annuity if you die
When you buy an annuity you can either nominate a reversionary beneficiary or choose a guaranteed period option.
- 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.
How an annuity affects the Age Pension
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.
The difference between an annuity and an account-based pension
Market performance doesn't affect conventional annuity regular payment amounts. This makes it one of the more stable retirement income options.
Like a conventional annuity, an investment-linked annuity provides regular payments. However, with an investment-linked annuity, your regular payment amounts are linked to investment performance. This gives the potential for payment amounts to go up or down, depending on the market.
With an account-based pension, your payments can be more flexible as you can withdraw additional amounts to cover one-off expenses.
Your money is typically invested in a range of investments, including shares, property and bonds. This gives potential for your money to grow but also exposes you to potential losses. This makes an account-based pension riskier than a conventional annuity.
Pros and cons of an annuity
Consider the pros and cons to decide if an annuity is right for you. Get financial advice from your super fund or a licensed financial adviser if you need more information.
Pros
- A regular guaranteed income regardless of how investment markets perform (conventional annuity).
- Suitable for someone who doesn't want to bear investment risk (conventional annuity).
- An annuity bought with super money is tax-free from age 60.
- An indexed annuity can help to protect you from the rising cost of living.
- Payments from a lifetime annuity will last as long as you do.
- If you nominate a reversionary beneficiary, a spouse or dependent will continue to receive some income after you die.
- If you choose a fixed-term guarantee period, your estate gets some money if you die during that time.
- Lifetime annuities can increase your access to the Age Pension because of more favourable treatment under the income and assets test
Cons
- You cannot choose how your money is invested (conventional annuity).
- Income payments may be lower than if invested, especially if purchased in a period with low interest rates, but payment amounts are guaranteed for the term of your annuity (conventional annuity).
- You can't change the terms of payments once they start.
- You cannot withdraw your money as a lump sum (some allow withdrawals, but significant penalties apply).
- Your payments might not keep up with inflation.
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, such as an annuity, account-based pension or lump sum.
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.