What is an annuity and how can it help you in retirement?

A fixed payment annuity is an investment product that you purchase with a lump sum – either from your super or non-super money. In return, the annuity provider pays you an income for a set period of time – or even for the rest of your life.

An annuity typically forms part of a retirement plan. It’s a good option if your goal is to have a fixed income in retirement for a set period of time, or for life. There are advantages in having a stable, secure income in retirement – but also drawbacks compared to other investment options.

An annuity is often used in combination with other sources of retirement income, such as an account-based pension and the Age Pension. It may be included as part of the income and assets tests for calculating the Age Pension. However, in some cases the assessable amount is less than other types of investments, which may increase your Age Pension entitlement.

You can buy an annuity from a provider using money from your super or outside of super. When you buy it, you can nominate when you want the payments to start and for how long. This can either be a fixed period such as 10, 20 or 40 years, or for the rest of your life.  You may also choose for payments to continue to your spouse if you pass away.

In return, an annuity provider pays you an agreed amount of money for the term of the annuity. Typically, you can choose to receive payments monthly, quarterly, half-yearly or yearly.

There are different types of payments you can choose to receive. If the payments are index-linked then it will increase in line with inflation. You can also link it to changes in interest rates or have a ‘market-linked’ rate that changes according to how financial markets are performing. In this case, the amount of the regular payment may go up or down, depending on what’s happening in markets, although it is still guaranteed for the life of the annuity. 

For annuities with a fixed term (rather than lifetime), you can choose to get a maturity amount. That includes whatever’s left of the original lump sum you paid, plus any investment earnings. However, if you choose to get a maturity amount, you’ll receive lower payments over the term of the annuity.

An account-based pension, also known as an allocated pension, is purchased with money from your super that is then invested by the trustee of the super fund on your behalf. Withdrawals from the account are paid to you as an income. The balance of your account will go up or down according to the performance of the investments in the account and the amount you withdraw. 

You can receive a regular income from an account-based pension but, unlike an annuity, it’s not guaranteed to deliver a fixed amount or to last for a set period. It’s available only for as long as you have money in your super account. However, you may have more flexibility about how much you can withdraw money from the pension if you need extra cash or in case of financial emergencies.

For fixed term annuities, you can nominate someone as a reversionary beneficiary to receive payments from the annuity if you die before the end of the term. Alternatively, a lump sum may be paid to your estate or beneficiary.

For lifetime annuities, you can nominate your partner as a reversionary beneficiary. This will ensure that if you pass away, payments will continue for their lifetime. Alternatively, if you die within a guaranteed period, a lump sum may be paid to your beneficiaries or estate.

If the fixed term annuity is purchased with non-super money in joint names, and one of the holders dies before the end of the annuity, the other holder may continue to receive payments or access the money as a lump sum.

The amount you receive from an annuity will vary depending on which one you buy and the terms and conditions it is offering. Financial institutions typically offer a range of annuity products with varying rates of payment and different features. That’s why it’s important to talk to your financial adviser and find the right annuity option for you.

Apart from any differences in product offerings, how much you receive from any annuity will be determined by how much you invested in it at the start, when the payments commence, how often you want to get paid and how long the annuity is due to last. The amount is also calculated on what the interest rates were when you took out the annuity, so if interest rates are high, you may be able to get a better return.