Guaranteed Income Streams

When planning for retirement the first step is to provide a cash reserve and the second step is to establish a secure income. A secure and stable income will provide you with peace of mind that you are able to cover your everyday living expenses.

Certain income streams can provide a guaranteed level of income either for life or a fixed period. The income payment is set at the start and may be increased to keep up with inflation each year.

You can purchase these income streams with either superannuation or non-superannuation money and both may have tax advantages.

With these income streams you can gain some peace of mind that you will receive a certain amount of income each year and know how long it will last for.

Features of Guaranteed Income Streams

Guaranteed income streams can be called either pensions or annuities. The main features of these income streams include:

• They provide a regular, pre-determined level of income over a set number of years or for your lifetime

• You can choose to have the income payments increased each year (indexation)

• If your income stream is payable for life you can select a guarantee period which ensures that income payments continue for at least that period to protect against a loss of capital in the event of your early death

• You can nominate your spouse as a reversionary pensioner to continue receiving income payments upon your death

• Some pensions may allow you to withdraw lump sums or receive some of your capital at the end of the term as a residual capital value

• No tax is deducted from superannuation money used to buy the income stream unless it is rolled over from an untaxed fund which will then have 15% tax deducted from any untaxed portion

• Tax is withheld from income payments by the income stream provider so the Pay-As-You-Go instalment system does not apply

• If the income stream is purchased with superannuation money the income payments are tax-free from age 60 and may receive a 15% tax offset under age 60

• Income streams purchased with ordinary money can be held in joint names

The agreed income payment depends on the amount you invest as well as other factors such as your age, whether or not you want to receive any of your capital as a lump sum at the end of the term and selection of a guaranteed period. The interest rate used to calculate the income payments will depend on the prevailing interest rate at the time of investment.

Choosing a Lifetime or Term Certain Income Stream

Guaranteed income streams can be payable for life (lifetime) or for a fixed number of years (term certain).

The main benefit of a lifetime annuity is that you no longer take on the risk that you may outlive your money. Your income payments will be paid for your lifetime regardless of what age you live to. Obviously, the cost of such guarantees is factored into the pricing of the income payments and for this reason a lifetime income stream may pay a lower level of income than a term certain income stream.

The main risk with a lifetime income stream is that if you die earlier than expected, the income payments cease (unless still within a guarantee period). In this case you may not receive a return of your full amount invested although some products may offer various guarantees on how much is returned. Details should always be checked carefully with the provider.

If you choose a guarantee period, and you die before the expiration of this period, the income payments will continue to your estate until the end of the guarantee period. Alternatively you can choose to nominate your spouse as a reversionary pensioner so that payments continue to be paid to your spouse for the rest of his or her life. These guarantee options provide you with greater certainty of the amount of capital and income to be returned.

As a general rule, if you expect to outlive your life expectancy (based on such factors as current health, family history etc.) and/or you seek a protection against longevity you should consider the benefits of a lifetime annuity. If you do not expect to outlive your life expectancy and/or you seek greater certainty as to the amount of capital and income to be returned a term certain income stream may be more appropriate. But you should always discuss which option is most appropriate with your adviser.

Commutation of Guaranteed Income Streams

In many cases, a guaranteed income stream may not allow you to commute your money back to a lump sum. You need to check the contract conditions carefully in the Product Disclosure Statement and think about how your future circumstances may change.

If you are able to stop the income stream and receive your money back as a lump sum, the amount you receive (commutation value) is calculated as the value of future payments. This depends on changes to interest rates, the remaining period and cancellation fees. This may not be financially attractive as the value you receive may be significantly less than the amount you invested, even after allowing for income payments already received. 

If you make a partial withdrawal the future value of income payments and the residual capital value will be adjusted to account for the amount commuted.

If you instead continue to receive the income payments in accordance with the original contract, you may not suffer a loss. This may be particularly relevant if an executor of your estate is making a decision whether to commute an annuity to a lump sum or continue the income payments.

Indexation of Income Stream Payments

Your living expenses will increase during your retirement in line with inflation. This is usually measured by the Consumer Price Index (CPI). It is important to have an income stream which increases over time to maintain your purchasing power.

You can choose for your income payments to increase each year by the CPI or a fixed indexation rate to keep up with inflation or maybe keep the income payments the same. This may reduce the initial payments to cover the costs of the indexation later in life but helps you manage your expenses.

Bear in mind there is the possibility that some items you purchase will increase at a rate higher than inflation and some at a rate less than inflation.

Centrelink Treatment of Guaranteed Lifetime Income Streams

If you are buying a new income stream the purchase price is initially counted as an assessable asset in the assets test, even if you are not able to make lump sum withdrawals. This value may reduce every six months to reflect the amount of your capital returned in any income payments.

Some non-commutable income streams purchased before 20 September 2007 may have exemptions under the assets test. You should discuss your circumstances with your adviser or with Centrelink.

• Income streams may be favourably assessed under the income test to help increase the amount of age pension you can receive. The income test rules depend on the type of income stream:

• Fixed term of five years or less – the balance is subject to deeming

• Fixed term of more than five years – a portion of the income received is not assessable income (see below)

• Lifetime – a portion of the income received is not assessable income (see below)

The non-assessable income for lifetime and fixed term income streams with terms longer than five years is calculated as:

*If joint names or a reversionary is nominated you need to use the longest life expectancy.

Death Benefits from Guaranteed Income Streams

Upon your death, a death benefit may be payable to your beneficiaries. If the death benefit is paid as a lump sum payment, this is a commutation. Please refer to ‘Commutation of guaranteed income streams’ above for issues relating to commutation values.

Lifetime income streams

• If you have nominated a reversionary beneficiary, the beneficiary will continue to receive income payments for his or her lifetime.

• If you have not nominated a reversionary beneficiary, a death benefit is payable to your estate only if you are still within the guarantee period. Payments can continue for the remaining guaranteed period or be commuted to a lump sum. 

Term certain income streams

• If you have nominated a reversionary beneficiary, the beneficiary will continue to receive income payments for the remaining term.

• If you have not nominated a reversionary beneficiary, a death benefit is payable to your estate. Payments can continue for the remaining term or be commuted to a lump sum.

Taxation

If the guaranteed income stream was purchased with superannuation money you are limited in who can be nominated as a beneficiary. Tax may be payable by some beneficiaries. You should discuss your options with your adviser to determine any estate planning strategies.

You can nominate anyone as a beneficiary for an ordinary money guaranteed income stream. Lump sum payments are paid tax-free.

For further information, or to book an appointment to ensure your retirement roadmap is in right order, contact Humble Goode Financial on 08 7477 8252 so we can go through all your options and see if this strategy is the right fit for you.

General Advice Warning:

The information on this website is intended to be general in nature and is not personal financial product advice. It does not take into account your objectives, financial situation or needs. Before acting on any information, you should consider the appropriateness of the information provided and the nature of the relevant financial product having regard to your objectives, financial situation and needs. In particular, you should seek independent financial advice and read the relevant product disclosure statement (PDS) or other offer document prior to making an investment decision in relation to a financial product.