Skip to content

 
Disclaimer | Download as PDF [373kB]

Retirement Income Streams

Information to help you plan your retirement years

Having an adequate income throughout your retirement years is a fundamental part of enjoying retirement. Retirement income streams are a popular investment choice for retirees as a way of producing regular income payments throughout retirement.

Gaining a good knowledge of retirement income streams involves understanding:

You can then work out what retirement income stream suits your needs.

On 9 May 2006, in the context of the 2006 Budget, the Australian Government announced its intention to streamline and simplify the current arrangements that apply to peoples' superannuation benefits. These were very significant changes for retirees and retirement income streams and this information incorporates those changes.

What are Retirement Income Streams?

During working life, and certainly well before retirement, we become used to earning a regular income. For most people the regular income comes in the form of a salary or wage which is paid at least monthly.

Because of the regularity of income during our working life, we usually adapt our spending to fit in with our income patterns. We might for example, buy the groceries on payday, or pay our major bills monthly.

And for most of us, managing our tax is not a big issue as our employer will have deducted income tax instalments from our pay before we receive the net amount. At the end of the year we receive a tax summary and lodge this with our personal tax return. All in all, this is a relatively straightforward process - we get a regular income and we don't have to budget for large tax bills at the end of the year.

By the time retirement comes around we usually have our income and spending patterns well practised, although these may change a little in retirement. At retirement, or at some stage before, we also need to plan what we are going to do with our retirement savings. Usually this will involve looking at what to do with our superannuation money and any other savings that we may have accumulated along the way.

One of the things you can do with some or all of your superannuation and/or other money is to invest it in a retirement income stream. When dealing with superannuation money, this may mean nothing more than receiving an income (instead of a lump sum) from your current superannuation fund, or it may mean using that money to purchase an income stream from a new fund.

Using a retirement income stream is simply a way of dealing with many of the financial issues to which you have become accustomed before retirement.

Retirement income streams are simply investments which allow you to obtain regular income and capital payments, and thereby provide you with a basis for managing ongoing income and spending patterns. And with most income streams, they are tax exempt thereby your gross amount equals your 'take home pay'.

Retiring does not mean that your need for regular income payments suddenly stops, so it's wise to consider this form of retirement income as part of your options in retirement.

There are various types of retirement income streams that we will examine, some of which may suit you and others may not. However, the basic principle is the same - investing to obtain a regular tax paid income stream.

Is a retirement income stream suitable for you?

There are lots of things to consider in planning for retirement. The number of years we spend in retirement is increasing and this part of our life will generally be a very long period of time.

Planning anything for such a long period of time is quite difficult as many things can change along the way. Planning retirement is no different, particularly when you consider what might change in future years.

For example, there is a fair chance that the house you live in at the start of retirement will not be your place of abode in 10 to 15 years time. You may decide at a future point in time to perhaps move to a smaller residence or move to another location. And further on you may consider other types of accommodation with access to medical care.

With properties there are always ongoing maintenance costs. The property will need painting, plumbing, electrical or other repairs at some point in time. Or you may decide to do some renovations.

You may also have the prospect of receiving an inheritance at some point in time and this may impact on how you plan your retirement. And of course there are always the uncertainties that happen in life which may involve substantial expenses.

So while having a regular income in retirement is a fundamental part of retirement planning, there are lots of other things to consider also. Having access to some cash is very important to meet special needs and having some flexibility in your financial affairs is usually sound planning.

Retirement income streams are not the only option you have for investing your retirement savings, however they can cater for many retirement needs, primarily the regular income need. We have identified just a few of the things that can change throughout the retirement phase of life and having the flexibility to alter your plans may be very important. Some retirement income streams are not very flexible and you should consider the advantages and disadvantages of each type of income stream carefully. After becoming more familiar with them you may decide that other options best suit your needs.

How can you benefit from reading this?

By taking a little time to read this you should be able to:

The retirement income stream concept is not difficult - as with any investment it just takes a little time to become familiar with all the terms and understand how the products work in practice. Income Streams - What types are there? There are two main types of retirement income streams - pensions and annuities. "There are two types of retirement income streams - pensions and annuities, but for the investor there is not much difference between the two types."

Income Streams - What types are there?

There are two main types of retirement income streams - pensions and annuities.

"There are two types of retirement income streams - pensions and annuities, but for the investor there is not much difference between the two types."

Pensions

A pension is the name given to income streams which are payable from superannuation funds, whereas an annuity is the name given to income streams which are generally payable from life insurance companies. There are many similarities between these two types of income streams.

There are a number of different superannuation funds which may provide pensions. For example, a public sector superannuation fund (such as for Commonwealth public servants), provides pensions to retired employees.

There are also publicly offered superannuation funds (often referred to as retail funds) which offer pensions. Usually, a person would 'rollover' their money from their superannuation fund to one of these funds and then commence to receive an income stream which happens to be called a pension.

While the funds providing the pension payments may differ, and indeed the type of pension payments may differ, their objective is still the same - to provide a regular income to people in retirement from their superannuation savings.

Annuities

An annuity is a little different in that it is purchased from a limited range of organisations, mainly life insurance companies. Traditionally, the word annuity has referred to situations where a person exchanges a sum of money for a guaranteed series of income payments. However, in more recent times there has been more flexibility incorporated into arrangements involving annuities.

If you invest in an annuity with a life insurance company you enter into a 'contract of insurance' with that company that covers the terms of the regular annuity payments. With a pension, you become entitled to receive pension payments by virtue of being a member of the superannuation fund. So legally there is a difference, but from a practical viewpoint, annuities and pensions operate in a similar way.

Pensions and annuities can have a lot of different product features and not all products offer the same features. There are two main groups of income stream products to learn about in terms of features and benefits. Some of these may be called pensions or annuities or you may find examples of both being offered by the one company. The key point to focus on first is what type of features do you want from your income stream?

Apart from the distinction between pensions and annuities, income streams also fall into two other categories, being those that are account based and those that are not account based.

Account Based Income Streams

The 'account based' variety is the most flexible type of income stream.

When you invest in an account based income stream, you have an investment account within the relevant fund.

Your investment account balance will increase as investment earnings are added to your account and decrease as you draw down regular income payments. For as long as the income stream lasts, you will have an account balance.

The most common type of account based income stream has been referred to as an allocated pension. Around 80% of all income streams are allocated pensions. More recently, market linked pensions (also called term allocated pensions) have become popular.

Non Account Based Income Streams

These are income streams which do not have an account balance. They generally have a purchase price and you exchange a lump sum of money for an income stream over either a fixed period of years, or for your lifetime. These payments are guaranteed to be payable by the organisation providing the product.

These are also referred to as fixed term pensions and annuities or lifetime pensions or annuities.

Terminology Used

There is a mix of terminology used to describe the various types of income streams.

Terminology Used
Type of Income Stream Category Common product names used
Pensions Account Based Allocated pensions

Market linked pensions
(also called term allocated pensions)
Pensions Non Account Based Lifetime pensions

Fixed Term pensions
Annuities Account Based Allocated annuities

Market linked annuities
Annuities Non Account Based Lifetime annuities

Fixed Term annuities

Who provides them?

Retirement income streams are provided by many different organisations and superannuation funds.

As mentioned earlier, annuities are incomes primarily provided by life insurance companies. These include allocated, lifetime and fixed term income streams. However not all life insurance companies provide all varieties.

Life insurance companies offering income streams (ie everything except allocated and market linked income streams) are subject to certain government regulations. To support the guarantees that they offer, these companies must carry a prudent level of 'capital reserves' so that they are able to withstand substantial fluctuations in investment markets without affecting the guarantees they have provided. These regulations are administered by the Australian Prudential Regulatory Authority (APRA).

On the other hand, pensions are incomes paid from superannuation funds. APRA also applies prudential controls to superannuation funds offering lifetime, life expectancy or fixed term pensions. Life insurance companies are subject to stricter requirements in terms of reserving assets to meet their payment obligations than superannuation funds. The most common types of funds providing income streams are:

Public Offer funds - the name merely indicates that the general public (subject to meeting certain conditions) are able to join the fund. Most public offer funds are operated by large institutions including banks, life insurance companies, credit unions, investment managers and financial advisory groups.

While there is a concentration towards account based income streams (allocated and market linked income streams) by this group of income providers they are also able to provide non account based income streams (lifetime and fixed term income streams).

Defined Benefit funds - these funds usually provide pension benefits to people who have been members of the fund for numerous years. The pension benefits are usually a percentage of the member's pre-retirement salary or wage and are usually payable for (at least) the lifetime of the member.

The most common examples of defined benefit funds paying pensions are funds established for State Government and Commonwealth employees.

Industry funds - a number of industry funds provide pension benefits to members. Those that pay pension benefits generally restrict their activities to allocated pensions. These funds first became popular when superannuation became part of various industry awards. Management of the fund includes employer and employee (often union) trustees.

Many of the large industry funds now have (limited) public offer status and are available to a wide range of workers.

There are many industry funds in Australia - some of the largest ones are Retail Employees Superannuation Trust (REST), Aust Super, and Health Employees Superannuation Trust of Australia (HESTA) amongst others.

Self Managed funds - these funds (which are also often referred to as DIY funds) make up a significant part of the Australian superannuation scene. Self Managed funds will have four or less members and more commonly one or two members only. While most are used by people in the pre-retirement phase of life, an increasing number are being used to provide retirement income streams.

Self managed funds can be used for the delivery of most varieties of pensions, but the vast majority are used to provide account based allocated pensions. These types of funds are subject to the same income stream rules as other types of superannuation funds, except in relation to lifetime, life expectancy and fixed term pensions where there are a few special rules.

Matching Income Stream features to your needs

There are many different income streams from which to choose; some are guaranteed, some are not, some are payable for life and others are payable for fixed terms (short, medium or long terms).

What you need to do is to match the most appropriate income stream (or streams) to your own specific circumstances.

If you want to retain the most flexibility with your financial affairs, then it is likely that an account based income stream will be the most suitable option. Alternatively, if you seek a high level of security and flexibility is not a major issue then a lifetime or life expectancy income stream may be more appropriate.

Of course, it may be that you want a bit of both - a high level of security and certainty of income for part of your money and a high degree of flexibility with the balance.

If this suits your needs then investing in more than one income stream may be the best option.

There is no limit on the number of income streams you may invest in. In fact, you may choose to invest in more than one income stream simply to spread your risk.

You should also consider how much of your available money to invest in income streams. They are not the only option available and it is always prudent to retain access to some money for emergencies or other irregular expenses such as home maintenance costs.

What are the risks?

As with any investment, retirement income streams involve some degree of risk.

Everyone views risks differently, however with income streams there are 3 main dimensions to risk:

Security - means how much risk is involved in the investments underlying the income stream.

Certainty - means how predictable the amount of the payments is from the income stream.

Outliving - means the risk that you will outlive your income stream payments. Only lifetime income streams do not have this risk.

However, within the range of income streams available there are ways in which you can reduce risks to a low level. Here are 8 key tips to get you started:

Tip 1 You can always invest in more than one income stream and they may be offered by more than one institution or fund - a tried and true way of not putting all your eggs in the one basket. Remember that there is no limit on the number of income streams you can invest in. However having too many may start to increase the costs of investing, particularly if your affairs get too complicated.
Tip 2 Be aware that there are very low risk income streams - such as those payable for lifetime and fixed terms - where an institution has usually provided a guarantee that they will continue to pay you an income at a specified level for a fixed number of years or for life.
Tip 3 With most income streams, particularly the guaranteed income streams, you may elect to have your annual income payments indexed to the Consumer Price Index (CPI) or some other set annual increase. By doing this you have some protection against losing the purchasing power of your money.
Tip 4 Within the income streams that carry the most risk (the account based varieties) there are usually numerous investment choices available. Some of them are quite low risk, and some products may even provide a guaranteed investment return for set periods of time.
Tip 5 When evaluating investment choices within account based income streams (allocated and market linked income streams), remember that there are choices available from quite low risk through to those that have higher risk. It is a case of matching the investment choices to the risk you are prepared to take (ie. how averse are you to receiving variable or even negative investment returns in short term periods?).
Tip 6 When considering the risk in account based income streams you should be aware that options offering some exposure to sharemarkets and property markets will generally, over the long term, produce higher investment returns than those that simply invest in fixed interest and cash.
Tip 7 Be aware that some income streams (the 'allocated' variety) allow you access to your capital, whereas other types of income streams either do not allow access or have restrictions on doing so. Capital needs must be considered carefully.
Tip 8 When considering investments in income streams, consider the risks that you may be taking in the context of all of your investments. For example, if you are investing only 25% of your money in an income stream which carries some investment risk, this may be quite appropriate if your other investments are invested securely (eg. term deposits).

Return to top

Budgeting for Retirement

Disclaimer