This pension product is still a mystery for many Aussies, but it shouldn’t be

As Australia’s superannuation system matures, many retirees face some challenges in handling their balances.

Australia’s superannuation system has two major advantages, it provides a cushion in our retirement years, and instead of sitting in the bank on minimum interest, the money has been invested by professionals for – hopefully – good returns in the accumulation phase.  

But once you have access to that money in the income phase, retirees are generally left on their own. It’s a problem the government has begun to recognise as it has been pressuring super funds to provide more services and advice to members about optimising their retirement income.

One option is annuities, but the Australian retiring cohort has been strangely resistant to this centuries-old investment product.

So what actually is an annuity? Basically, you give a financial institution a sum of money, and they pay you an income in return. Investors decide the sum chosen and then the income is calculated from that investment. They can be indexed to cover the rise of cost of living. It’s a type of term deposit, where you can’t touch the initial investment, if that makes it easier. 

Nothing new

Annuities are one of the oldest financial ‘products’. They date back to Roman times when a contract for a guaranteed income source was known as an ‘annua’. In exchange for a one-time payment, the recipient would receive a lifetime income. 

There are two types, term and lifetime, and as the names would suggest, one goes for a set term and the other is a lifetime product. 

And if you are looking for a steady income, instead of the challenge of investing the money yourself, they make a lot of sense. 

Challenger head of retirement income research Aaron Minney says as super balances increase, Australians are facing a few knowledge gaps.

“What did people use to do when they retired? They maybe had $70,000, went out and got a new car, maybe took a caravan trip, updated a kitchen, and that was it, then they had to go on the pension,” Mr Minney said. 

“But then as people have got more and more super, that means they’ve got a problem to deal with, because they’ve got money that they’ve actually got to spend.

“People have $200,000 now, or $400,000 to $500,000 for a couple, and they’re not going to get the full Age Pension. They’ve got to find investments that actually work for them. And we don’t equip people to do that very well.

“If you take it to the crux of it, it’s their [super funds] members that are suffering because the members don’t know what they’re doing.” 

Struggling to choose

Mr Minney said the average Aussie struggles to choose investments, which is why super funds were invented in the first place; funds use their financial knowledge to invest that money for you. However, once people qualify for their super, retirees have a bunch of money and are generally left on their own. 

Mr Minney said part of that knowledge gap was people simply don’t know what financial retirement products are available. He said academic research has found about 55 per cent of Australians’ understanding of annuities is a bit sketchy.

“We are sitting there going ‘oh why aren’t people running around buying all their retirement products?’ Well half of them don’t even know what they are.” 

Mr Minney said if Australians are a bit wary about annuities, the industry has done itself “no favours” in educating the public about investment options.

“We’ve focused on the bells and whistles and the product smarts and we’ve talked about this complexity as if we’re product geniuses, but it’s not what the consumer wants to hear,” he said. 

Mr Minney said annuities are both simple and complex. 

“It’s simple to use … give people a steady income they will know how to use it. But if you tried to build the investments  for that income yourself, it’s pretty complicated.”

Pros and cons

So what are the advantages and disadvantages of annuities?

Well, as a steady, guaranteed income, they are ideal for people who are risk averse. Some people love to fly by the seat of their pants and take responsibility for their own investments, but others just want to see some money turn up in their bank accounts each month and avoid the stress. And as you age, the appeal of a regular annuity payment without worrying about where it came from will probably increase. 

And unlike superannuation, they are not subject to the whims of the market, so your income is steady regardless of the financial environment. 

A lifetime annuity will last as long as you do and if instead you decide to go with a fixed term, but if you pass away before the end date, your estate will be given some money.

With some products, you can also nominate your spouse to receive some income when you die, although the income amount will be less. 

In Australia, an annuity bought with super money is tax-free from age 60.

On the flip side, you have no power over where the money is invested, and you can’t change how much money you receive once payments start. 

You also lock your money away and should plan not to redraw the lump sum and linking the indexation to the Consumer Price Index can significantly affect your payments depending on the state of the economy. (It is possible to access your capital if your circumstances change, but there can be significant costs to unwind the annuity).

Australians are also living longer. What may be good for you now, may not be suitable for you in 20 or 30 years. Locking in an annuity may not be the answer as your life costs change. 

Would you consider an annuity? Why not share your thoughts in the comments section below?

Also read: Working out how much to spend in retirement

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