Annuities in Australia: Pros and Cons
In Australia, we have relatively few guaranteed income products and this represents a significant disadvantage for many retirees who are seeking a secure and reliable product to meet or all or part of their income requirements in retirement. With the exception of defined benefit or final salary pensions, which are now generally limited to politicians and public servants, the only guaranteed income products available in Australia are currently annuities.
Annuities can only be provided by life insurance companies, and these companies are regulated by the Australian Prudential Regulation Authority (APRA), but are generally marketed by broader financial organisations holding a life insurance license. Examples of some of the companies offering annuities include BT (Westpac), Challenger and Comminsure (CBA).
The following types of annuities are generally available in Australia:
- Fixed term annuities: these provide a regular income stream for a fixed number of years (i.e. fixed start and end dates); you can choose to have your initial investment capital returned at the end of the agreed term, or gradually during the term as part of your regular payments
- Lifetime annuities: these have no fixed term and are designed to provide payments for the rest of your life; some lifetime annuities have a guarantee (or withdrawal) period, allowing you access to your capital early, if required
- Complying annuities: an annuity purchased prior to September 2007 that is either 50% or 100% exempt from the Assets test; existing complying annuities may be rolled over to a new annuity and maintain their asset test exemption status
Advantages of Annuities:
- Annuities provide you with a guaranteed income, regardless of how markets perform, and payments can generally be made monthly, quarterly, six-monthly or annually.
- Annuity income payments are tax free if you invest with super money and are aged 60 or over
- Annuities purchased with super money before age 60 will have the taxable portion taxed at your marginal tax rate, however, you will receive a 15% offset
- Only the income component (if any) of an annuity purchased with non-super money is taxable
- You do not pay tax on investment earnings
- Indexed annuities can protect you from the rising costs of living
- The term (length of the annuity policy) can be selected by the individual investor at the outset. Fixed term annuities are generally available for terms of between 1 and 50 years, whilst the term of a lifetime annuity is the rest of the investor´s life – no matter how long they live
- Residual Capital Value (RCV) - in some cases a lump sum or "Residual Capital Value" may be returned to you at the end of the contract
- Some annuities let you nominate a loved one or dependent as a "reversionary beneficiary". This means that they will receive some level of income if you die
- You can choose a fixed term guarantee period, where some money will be paid to your estate if you die during that time
- Generally, annuities carry no product fees – that is they do not charge separate management, administration, performance, entry or exit fees - they are built into the pricing of the annuity
Disadvantages of Annuities:
- Your money is locked away, perhaps for decades - and once you buy an annuity, you can’t generally withdraw your money. However, some new annuity products do allow access subject to certain conditions.
- You cannot choose how your money is invested by the fund manager
- Extra features have a cost - opting for indexed payments or a residual value, for example, may mean your regular income payments are lower.
- The nature of an annuity may mean that it is backed by very conservative investments. Your income may be relatively low, but secure, and effectively an annuity might pay less than a market-linked investment
- At present, only a few companies are offering lifetime annuities in Australia and that may be reflecting a relative lack of competition in terms of price and features
- Inheritance - other than during a guaranteed period, money cannot be passed on to your estate from a lifetime annuity (unless you have a minimum payment term as part of the annuity contract, or a "reversionary annuity" which means your spouse or dependent gets income payments if you die).
Impact on your Age Pension entitlements:
- The amount in your annuity will be assessed under the Assets test for the Age Pension (unless purchased prior to 20 September 2007, where different rules apply);
- Part of the income you receive each financial year is currently assessed under the income test (i.e. the assessable income is calculated by reducing the gross annual payments by the deduction amount that reflects a return of the purchase price). From 1 January 2015, any annuity income stream has been treated as a financial asset and assessed using the deeming rules.
- New means test rules for lifetime annuities come into effect from July 1, 2019. For qualifying products the income test will include only 60% of any income with only 60% of the nominal purchase price treated as an asset. When the individual reaches the life expectancy of a 65 year old male (currently age 84) - subject to a minimum five year period - then 30% of the purchase price is included for the rest of the individual’s life. These new rules should now make lifetime annuities a more attractive product - particularly for individuals who currently qualify for only a partial aged pension, or just fail to qualify for a pension.
This information is intended as a very general introduction only. Whilst an annuity may be a viable option in terms of your retirement income, each individual's circumstances will differ, and you should seek professional advice to explore your options further.