What is an annuity?

An annuity gives you a guaranteed amount of income for a set period of time (say five, 10, 20 or even 40 years) or the rest of your life. If you choose a fixed payment option, you know how much income you’ll receive and how long it will last. It can give you a steady, reliable income so you can   plan your life with certainty.

You pay a lump sum to the annuity provider and they invest the money for you. You can buy an annuity using a lump sum from your super or savings outside of super.

If you choose a fixed payment option, the annuity provider takes on all the market risk. This means you get guaranteed, regular payments for a period of time that you choose – regardless of how the market performs.

Typically, you receive a portion of your original investment back together with the agreed rate of return such that your investment balance runs to zero at the end of the annuity term. Alternatively, you could choose to receive a set amount at maturity and lower regular payments. 

The amount of income you’ll receive depends on:

• how much you invest.
• the term of the annuity
• how much leftover money you want to receive at the end of the term (if any) 
• the interest rate at the time you invest. 
• the type of annuity you choose.

An annuity does provide some flexibility around your retirement income. It enables you to choose from a range of income options, including:

• Fixed term or lifetime options – choose the number of years that you want to receive an annuity or choose to receive one for your entire life.
• Indexation of the income payments – choose to have your annuity increase each year by a percentage in line with inflation, or even in line with share market returns
• Income payment frequency – you can receive payments monthly, quarterly, half-yearly or yearly.
• Investing with super or non-super money.
• Having some or all of your lump sum returned at the end of the term.
• Being able to withdraw funds from your annuity at any time    .
• Nominating a reversionary (where available) – so if you pass away before your annuity finishes, your spouse or dependant could receive the annuity instead.
• Nominating a beneficiary – so if you pass away, someone you choose will receive the remaining money in your annuity or a guaranteed amount.

An annuity could be right for you if you’d like a guaranteed regular income for a fixed amount of time – or even for your lifetime. Unlike other retirement income streams, if a fixed payment option is chosen, your guaranteed annuity income won’t be affected when financial markets go up and down.

An annuity is typically used together with other sources of income in retirement, such as an account-based pension or the government Age Pension. Some lifetime annuities might even give your Age Pension a little boost as they may get favourable treatment for the social security tests. Its important to understand how these can work together to give you the right balance of peace of mind in retirement and access to your money when needed.

Annuities do have drawbacks, too. They typically are invested conservatively and therefore have lower rates of return. There is a chance that your income payments may not keep up with your income needs, for example – and if you choose a fixed term annuity there is a risk that you will outlive the term.

It’s also important to know you may lose some of your initial investment if you make an early withdrawal or pass away early.

With an account-based pension (also called an allocated pension) you use your super money to provide your pension, which the trustee of your super fund invests on your behalf. 

You’ll receive a regular income but it’s not guaranteed to last for a set period. It’s available for as long as you have money in your account.

Unlike an annuity, the balance of your account-based pension will go up or down depending on how your investments perform, and how much money you withdraw. In strong markets, your account-based pension could provide higher growth to your retirement portfolio as well as access to extra cash when needed.

It’s important therefore to seek advice to ensure you’ve considered the best option for you.