The annuities vs pensions battle
The GFC has given retirees good reason to drop their swords and reassess annuities as an alternative to an account-based pension (ABP).
With the proposal to provide the same tax treatment to deferred annuities as applies to super from 1 July 2014, dismissing an annuity based on inhospitable taxation will not be an option.
A deferred lifetime annuity is essentially an income stream with a deferred commencement date (that is, purchased now for payment from the date on which the recipient reaches a particular age etc).
Currently, earnings derived from 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.
Annuities are a lump sum payment to the company in exchange for either life or a fixed term and are a guaranteed fixed annual income. They are offered by APRA-regulated companies and generally cost more than ABPs because operational costs and risks are assessed at the time of commencement by the provider.
The purchaser can also choose to have no money left or a particular amount paid back at the end of a fixed term.
ABPs are an income stream from investments which require a minimum drawdown each year in accordance with the SIS regulations, and can start or stop (be commuted).
The ABP can offer lump sum withdrawals, and generally costs less than annuities because purchasers do not pay premiums to cover risk associated with the guaranteed payments.
Case study
Annuities appeal to someone such as Budgeter Bob.
If the market moves favourably, Bob is locked in and misses out. His peers may be reaping the rewards of the market while Bob receives his usual income.
Bob may have purchased an indexed annuity to safeguard against inflation but this will be the extent of increased payments. If the market moves unfavourably, then Bob is protected.
If Bob dies a month after the annuity begins, there are a couple of options. If he did not buy a reversionary annuity or an annuity with a minimum payment term, then the annuity provider keeps the lot. If the annuity was bought as reversionary or with a minimum payment term, then Bob’s spouse or dependent could receive the payments until the term ends.
But, if the company providing the annuity goes belly up, then Budgeter Bob is not covered by the government protection for certain deposits with banks.
ABPs, meanwhile, are likely to appeal to Fast Eddie.
If the market moves favourably, then Eddie – depending on the investment strategy and holdings of the super fund – may reap the rewards, and can increase pension payments or take a lump sum.
If the market moves unfavourably, then Eddie may need to reassess his investment position to continue receiving the same income. Worst-case scenario: Eddie will need to reduce his income.
If Eddie dies a month after commencement, then there are a few options depending on how the pension was set up (reversionary, or the residual is 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 fund’s trust deed.
If the market moves unfavourably, Eddie must draw the minimum annual amount required for an ABP, which may deplete his already reduced capital.
If Fast Eddie wants to safeguard against the next GFC, or if Budgeter Bob wants more flexibility for a lump-sum drawdown, then they could consider splitting retirement savings into an annuity and into the concessional super fund environment.
Michael Hallinan, special counsel, Townsends Business & Corporate Lawyers
