Annuity

An annuity is a financial product you buy from a life insurance company or friendly society, usually with super money at retirement. It pays a guaranteed income for a fixed number of years or for the rest of your life. You hand over a lump sum, the insurer commits to a payment schedule, and the payment arrives whether the market rises or falls. A $500,000 annuity at 5.5 percent with 5 percent annual indexation pays roughly $30,000 a year at age 65 - the payment is a contract, not a return. MoneySmart's framing is the honest one: the annuity brings certainty, and certainty has a price.

The structure has two main variants. A conventional annuity fixes the payment at purchase - flat, indexed with inflation, or stepping up by a set percentage. An investment-linked annuity guarantees the duration but not the amount, with payments moving on the performance of the chosen option. Payments stop at death unless a reversionary beneficiary was nominated or a guaranteed period was chosen. The lump sum is effectively locked: most annuities cannot be withdrawn, and the withdrawals that are allowed carry significant penalties.

Bought with super, the annuity counts against your transfer balance cap, so the cap check applies as for any income stream.

The mechanics run through the purchase price and the term. You choose the amount, the payment frequency and the duration - a fixed number of years or life - and the insurer prices the payment from the purchase price, the term and the prevailing interest rate environment. A conventional lifetime annuity paying $30,000 a year on $500,000 is a 6 percent payout rate; the payment is credited monthly, quarterly or annually, and indexed annuities step it up each year by the agreed percentage. The terms are set at purchase, and there is rarely flexibility to change them after the cooling-off period ends.

The comparison with the account-based pension is the mechanism most retirees weigh. The account-based pension has minimum drawdowns of 4 to 14 percent, investment choice and the ability to take lump sums or close the account; the annuity has none of that flexibility and none of the market risk. Both count against the $1.9 million transfer balance cap, and both are means-tested for the Age Pension. Lifetime annuities get more favourable treatment under the income and assets tests, which is the quiet argument for them. The account-based pension entry covers the flexible version, and the retirement income calculator runs the mix.

For an Australian reader, the annuity is the sleep-at-night option in the retirement income decision. The payment arrives regardless of what the ASX did this quarter. The trade is real: the capital is locked, and the payments erode with inflation unless indexed. The account-based pension at the same balance keeps the flexibility. The transfer balance cap entry covers the shared limit, and the longevity risk entry covers the problem the lifetime version is built to solve.

MoneySmart's guidance treats the annuity as one of several retirement income sources, mixed rather than all-or-nothing. A colleague named Brent (yes, that Brent) put his mother's entire retirement balance into a fixed annuity with no indexation in 2021. Four years of inflation later the payment bought roughly 11 percent less, and the flexibility to fix it was in the cooling-off period she never revisited.

The highest-leverage thing most retirees can do is treat the annuity as one leg of a mix rather than an all-or-nothing election. A lifetime annuity for the floor, an account-based pension for the flexibility - that is the shape.