Retirement Incomes: advantages and disadvantages

Lifetime annuity

Advantages:

~ income is guaranteed for life

~ income may be indexed for inflation (at a rate of 3.0% pa), so purchasing power is not eroded by increased living costs

~ low exposure to investment risk

~ annuity purchase price attracts a 50% exemption under Centrelink’s Asset Test

~ income is Centrelink friendly, as a significant portion is not assessed under Centrelink’s income test

~ income is tax effective, as it includes a tax deductible amount and attracts a 15% pension rebate on the assessable income amount

~ where a reversionary pensioner has been nominated (eg, a spouse), they may choose to continue to receive regular pension payments, or commute the remaining capital to a lump sum

~ where pensioners die before the end of the guarantee period, the value of the remaining payments will be paid to their estate

Disadvantages:

~ no access to capital invested (ie, the annuity is non-commutable)

~ returns linked to prevailing interest rates at time of investment; if interest rates increase, pensioner will not benefit from higher income returns (if

interest rates fall, pensioner will benefit from higher interest returns).

~ income payments do not vary to reflect investment market performance

~ where pensioners die after the guarantee period, any entitlement to income or capital is forfeited (unless a reversionary pension has been nominated)

Term annuity

Advantages:

~ income is guaranteed for the term of the annuity

~ income is indexed for inflation (at a rate of 3.0% pa), so purchasing power is not eroded by increased living costs

~ low exposure to investment risk

~ annuity purchase price attracts a 50% exemption under Centrelink’s Asset Test

~ income is Centrelink friendly, as a significant portion is not assessed under Centrelink’s income test

~ income is tax effective as it includes a tax deductible amount and attracts a 15% pension rebate on the assessable income amount

~ where a reversionary pensioner has been nominated (eg, a spouse), they may choose to continue to receive regular pension payments, or commute the remaining capital to a lump sum

~ where pensioners die before the end of the guarantee period, the value of the remaining payments will be paid to their estate

Disadvantages

~ no access to capital invested (ie, the annuity is non-commutable)

~ returns linked to prevailing interest rates at time of investment; if interest rates increase, pensioner will not benefit from higher income returns (similarly, if interest rates fall, pensioner will benefit from securing higher interest returns).

~ income payments do not vary to reflect investment market performance

Allocated pensions

Advantages:

~ investment earnings on capital are tax-free

~ no capital gains tax paid for any capital realised — only drawn income is taxable

~ capital can be accessed at any time by making lump sum withdrawals (which are subject to ETP withdrawal tax)

~ income is tax effective; undeducted contributions will include a “tax-free” income component

~ income not received “tax-free” will be taxed at the marginal tax rate, however pensioners receive a 15% tax rebate

~ these are Centrelink friendly investments, as a significant portion of income is exempt from Centrelink’s Income Test

~ capital is not lost on death; balance can be paid to dependants, or in

accordance with will or estate

~ where a reversionary pensioner has been nominated (eg, a spouse), they may choose to continue to receive regular pension payments, or commute the remaining capital to a lump sum

Disadvantages:

~ income received will include a Centrelink deductible amount, but the account balance will be assessed under Centrelink’s Asset test

~ income payments not guaranteed; payments continue only until account balance runs out; account balance will depend on the performance of the underlying assets and the level of income the pensioner elects to receive

Term allocated pensions

Advantages:

~ tested under the pension RBL — allows a greater super benefit to be

concessionally treated

~ treated concessionally under the Assets Test for Social Security — 50% of purchase price/account value not counted

~ The pension term can be selected by the primary pensioner from a range of different terms; this gives more flexibility to choose a term closely aligned to the pensioner's needs

Disadvantages:

~ no guarantee of investment performance — in a negative investment climate, the annual payment could fall to reflect negative returns

~ the pensioner cannot select an annual pension amount — only one amount can be paid pa, according to statutory payment factors applying

~ no fixed annual income amount — both the changing value of the account and each new financial year’s payment factor will usually see a changing annual payment from year to year

~ limited recourse to a lump sum withdrawal

~ no guarantee that the pension will last as long as the life of the primary beneficiary

~ no provision for a residual capital value upon the death of the last survivor