Understanding annuities: should you buy one?
Challenger Guaranteed Annuity (Liquid Lifetime)
It's an old-fashioned word but an annuity - such as the this one from Challenger - is simply a product you buy from a financial services company that provides you with a guaranteed regular income either for life or a defined period in return for a lump-sum investment.
That investment does not have to come from a super fund but may not be tax free if funded with non-super money.
For super-paid annuities, the income is generally tax free once you are over 60 and you can choose from a variety of annuity options, including lifetime, term certain and reversionary.
Term-certain annuities have fixed start and end dates, ranging from one to 50 years. Lifetime annuities provide regular payments for the rest of your life.
You can continue the payments for the lifetime of a second person (your "reversionary"), in full or in part, after you die.
You can build inflation or partial inflation into your payments, but it will mean you receive less income in the early years to pay for it.
Why should I buy one?
An annuity is a worry-free investment that will deliver a regular income. You may want to ensure that you have money to cover fixed and regular expenses, such as rates, strata fees and insurance.
An annuity income stream will ensure that there will be money to cover these expenses.
When the sharemarket dives you won't have to worry. The annuity payments will continue regardless. Nor are they affected by interest rate movements.
Lifetime annuities deliver the best result in terms of returns if you live longer than the actuarial tables say you are likely to.
If you live to 110, the lifetime annuity will continue to pay an income stream. Annuities, particularly term-certain versions, are meant to be held for the duration.
You can have your capital returned at the end of the term or gradually as part of the regular payments. If you want to withdraw your annuity, in most cases your investment will be returned but it will be discounted.
The income stream will remain steady, so if you don't index for inflation it will buy less each year as prices rise. You will not benefit from any sharemarket growth.
A risk with these products is that the company issuing the annuity will go broke, although Australian annuity-issuing companies are regulated and monitored.
How much income?
Take the example of an income stream for a 65-year-old from $100,000. It would vary depending on whether the person was male or female.
A lifetime annuity, with a death benefit of 100% of the purchase price payable to his estate or nominated beneficiary if he died within the first 15 years of the policy, would give a man an annual income of $6100.
A woman would get $5984. The implicit rate of return is about 6%pa. If $400,000 is invested, a 65-year-old man can expect to receive $24,420 a year and a woman $23,937.
A Challenger Liquid Lifetime annuity offers a voluntary withdrawal feature, so that not all your money is used up to pay the income stream.
You may decide that you want 100% of your purchase price back after 15 years (at 80 years of age). In that case, a 65-year-old man or woman would receive $4169 a year, with an implicit earning rate of 4.25% a year.
If you want only 50% of your capital returned after 15 years, the annual income stream rises to $6458, implying an earnings rate of 4.1%.
Both lifetime annuities and 100% capital return annuities with terms of six years and above receive favourable treatment under Centrelink asset and income tests for the age pension and also for daily aged care fee subsidies and the seniors' card.
It is best you discuss which product option suits you best - reversionary or non-reversionary, indexed or unindexed - with a financial adviser.
- Worry-free investment.
- There are no additional fees. They are built into the product.
- The implicit earnings rates appear to be reasonable in the current low-interest-rate environment.
- The issuer could go broke.
- Challenger has a long track record.
- Inflation will eat into the return, which means that each year it will buy less, unless you choose the indexed option.
- If you have longevity in your family, you may do well out of a lifetime annuity. If you tend to stay awake worrying about volatile share prices or interest rates, then an annuity will calm you.
- An annuity certainly has a place in a retirement plan, although I would invest only a portion of my retirement savings in one.