Income streams, pensions and annuities
05 . 11 . 18
By Ignatius Wilson
The many different labels for similar income stream investments can be confusing, but they have specific important meanings, including transition-to-retirement (TTR) and account-based pensions. I will take a look at how these investments and income streams can support you in retirement and why you need to consider these products whatever stage of life you are at.
Annuities are a regular payment made from an investment to its owner. They pay a guaranteed amount over a set period. Annuities are paid at most monthly and you agree on the time, frequency, dollar value and other conditions of the payments when you buy the product.
Also called fixed-term or lifetime pensions, the benefits of annuities include that they pay the same, agreed amount no matter how the underlying investments perform. This puts the risk on the vendor and vendors hedge against that risk by charging relatively expensive rates.
Furthermore, because of this one-sided risk relationship, annuities may be strongly hedged against volatility, and pay below-market returns over the long term. On the other hand, another positive is that there is a favourable tax treatment of annuities purchased with superannuation savings.
A pension is a general term for social support payments, including the age pension and disability allowance, as well as being shorthand for account-based pensions which I will address shortly. From an investment viewpoint, a pension is analogous to a super fund, operated by an employer who contributes money throughout the time an employee works there.
Once the employee retires they receive an income stream or lump sum from the pension as well, perhaps, as other benefits. This is more common overseas as superannuation has overtaken this here. Many public servants including parliamentarians, however, do receive a special pension as well as access to super.
The transition-to-retirement income stream is a clever way to access your super investment while you are still working. This allows you to add to your super at the same time as earning duela income, from your employment and TTR income stream.
The benefits of this include paying less tax on your effective income if you are over the age of 60. This can be done by salary-sacrificing more of your employment income to your super and withdrawing super through a TTR income stream at the same time.
The downsides are that although you may create a two-way, tax effective asset stream between your employment income and TTR income, if it is not maintained carefully you will simply reduce your super savings. By adding complexity and financial intermediaries (banks, your super fund, financial planners, accountants) who have the expertise to carry this out, you leave yourself open to high fees and ongoing expenses.
- Account-based pensions
Although I have listed this income stream last, an account-based pension is required before TTR and other retirement-funding income streams are available. To set one up, transfer super savings from your superannuation fund after you have satisfied a condition of release.
There are minimum and maximum drawdowns from this account between 4-14% per annum. The positives of setting up an account-based pension is that it is a structured way to access your super savings. Further, as I mentioned, this is needed to access other types of income streams. You have more control of the amount and frequency of your drawdowns and you can roll the account back into your super at any time.
The downsides include no guarantee of income stream beyond what is in your account and a third party has not taken on of the investment risk like in an annuity.