30/10/2013

The GFC has given retirees good reason to reassess annuities as an alternate to an Account Based Pension.  Who can blame them; feeling secure in retirement is of paramount importance irrespective of background or balance.  Before rushing into any income stream decision it is wise to assess different aspects of annuities vs pensions.  

With the proposal from 1 July 2014 to provide the same tax treatment to deferred annuities as applies to super, dismissing an annuity based on inhospitable taxation will no longer be an option.  A deferred lifetime annuity is essentially an income stream with a deferred commencement date (ie. purchased now for payment from the date on which the recipient reaches a particular age etc).  Currently, earnings derived by an annuity during the deferral period are subject to greater tax than earnings derived during the accumulation phase of super.  The proposal for annuities seemingly evens the playing field in that regard.

Annuities  
•    are a lump sum payment to the company in exchange for either life or a fixed term (5, 10, 15, 20 years etc)
•    are a guaranteed fixed annual income
•    are offered by APRA regulated companies holding a life insurance licence
•    will generally cost more than an Account Based Pension as operational costs and risks are assessed at the time of commencement by the provider
You can also choose to have no money left or a particular amount paid back at the end of a fixed term.

Account Based Pensions
•    are an income stream from investments which require a minimum drawdown each year in accordance with the SIS Regulations  
•    can start or stop (be commuted) at times permissible by the Regulations
•    can offer lump sum withdrawals or deposits made in accordance with the Regulations  
•    will generally cost less than an annuity as you won’t be paying a premium to cover risk associated with the guaranteed payments.

Annuities certainly appeal to someone like Budgeter Bob.

If the market moves favourably – Bob is locked in and misses out on the benefits.  His peers may be reaping the financial rewards of the market while Bob continues to receive his usual income.  Bob may have purchased an indexed annuity to safeguard against inflation but this will be the extent of an increase to his payments.

If the market moves unfavourably – Bob is protected.  

If Bob dies a month after commencement?  If Bob hasn’t purchased a reversionary annuity or an annuity with a minimum payment term then the provider of the annuity simply gets to keep the lot.  If however the annuity was purchased as a reversionary annuity or with a minimum payment term then Bob’s spouse or dependent could receive the payments until the term ends or possibly even receive a lump sum payment.

Risks? If the company providing the annuity goes belly up; Budgeter Bob is not covered by the government protection to certain deposits with banks.  

Account Based Pensions are likely to appeal to someone like Fast Eddie.

If the market moves favourably – Eddie, depending on the investment strategy and holdings of the super fund may reap the rewards.  Eddie could take advantage by increasing his pension payments or perhaps indulge in a lump sum draw down.  

If the market moves unfavourably – Eddie may need to reassess his investment position if he wants to continue to receive the same income.  Worst case scenario Eddie will need to reduce his income.

If Eddie dies a month after commencement? Depending on how the pension was set up; it may be reversionary, or the residual may be payable under a binding death benefit nomination or to his estate and pursuant to his will.  If nothing specific is in place it will be paid pursuant to the rules in the Trust Deed of the super fund.

Risks? If the market moves unfavourably Eddie must continue to draw the minimum annual amount required for an Account Based Pension which may deplete his already significantly reduced capital.


If Fast Eddie wants to safeguard against the next GFC or if Budgeter Bob is wanting greater flexibility to perhaps have the odd lump sum drawn down - they could consider a split of some of their retirement savings into an annuity and some remaining in the concessional super fund environment.  Either way; Fast Eddie and Budgeter Bob will need to be aware of all the risks and benefits for them personally before deciding the outcome of the income stream smack down.
 

For more information on this article, please call Townsends Business & Corporate Lawyers on (02) 8296 6222.