Understanding annuities

The main providers of annuities are life insurance companies. They can be purchased with superannuation monies (via a rollover) or with non-superannuation monies. Annuities receive similar Centrelink treatment as applies to similar income streams issued by superannuation funds.

While account based annuities purchased with a superannuation rollover are allowed, these products are rarely provided by life companies given the lack of demand. Instead, most people seek annuities that pay a guaranteed income for a defined period, eliminating the investment risk associated with account based products.

Lifetime annuities

Lifetime annuities provide a regular income until the death of the principal annuitant (i.e. the purchaser) or the reversionary annuitant where specified at the time of purchase. Lifetime annuities allow the purchaser to select a guaranteed period at the commencement of the annuity, up to a maximum of 20 years or life expectancy at commencement (whichever is lesser). This provides some protection against early death.

Should the annuitant and any reversionary die prior to the end of the guaranteed period, the present value of any remaining income payable until the end of the guaranteed period is paid either to the named beneficiaries, or the estate. Where the annuitant and any reversionary nominated die after the expiry of the guaranteed period, the annuity ceases and no further payments are made.

Fixed term annuities

Fixed term annuities, also known as ‘term certain annuities’ have a fixed term agreed upon at commencement. Where the agreed term is based on the purchaser or reversionary’s life expectancy, they’re known as ‘life expectancy annuities’.

Income payments are paid for the term specified to the annuitant or any reversionary, should the annuitant die. If both the annuitant and the reversionary die within the fixed term, the present value of the payments over the remaining term are paid to either the named beneficiaries or the estate.

Annual annuity payment requirements

In all cases, payments must be made at least annually.

For fixed term annuities purchased with ordinary money, there’s no legislative minimum payment that needs to be made. Instead, the annual payment is a function of the offered earnings rate.

It’s possible to structure the payment schedule so that all or part of the original purchase price is returned at maturity. This return of the initial capital outlay is known as a Residual Capital Value (RCV). The larger the RCV, the smaller the payments received each year.

For annuities purchased with superannuation monies, the annual payment amount is determined by the product provider by applying the offered earning rate. However, the payments will still have to comply with either:

• the minimum payment percentages applied to account based pensions; or
• provided the requirements relating to the term of the annuity contained in regulation 1.05 (11A) (b) (ii) (A) are met, the minimum payment percentages applied to account based pensions for the first year, with subsequent years varying in line with an approved indexation arrangement;
• the new certain ‘innovative superannuation income stream’ standards, which require:
  • the member to have satisfied a full condition of release such as retirement, attain age 65 or is permanently incapacitated,
  • benefit payments are paid at least annually throughout the beneficiary’s lifetime subject to any payment deferral period,
  • after benefit payments start, there is no unreasonable deferral of payments from the income stream,
  • there are restrictions on the amount that can be commuted based on a declining capital access schedule

Where the first of the minimum payment options is selected, it’s possible to structure the payment schedule so that all, or a part of the purchase price of a fixed term annuity is returned as an RCV at maturity.