Types of Income Streams - Account Based

Account based income streams are 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 popular types of account based income streams have been referred to as allocated pensions and allocated annuities. An allocated pension is provided from a superannuation fund, whereas an allocated annuity is an annuity contract issued by a life insurance company. Apart from this difference they are almost identical.

When you are considering account based income streams, you should be aware that you can only use 'superannuation money' to invest in them. 'Superannuation money' means any money that is within a superannuation fund and certain types of superannuation lump sum payments.

So any savings that you have outside superannuation would need to be contributed to a superannuation fund prior to investing in an account based income stream. Anyone can contribute to superannuation prior to age 65 without satisfying eligibility rules. After age 65, eligibility conditions need to be met. To contribute to a fund you need to have worked at least 40 hours within a consecutive 30 day period in the financial year in which the contribution is made.

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Access to your money

Account based income streams offer you the most flexible option as far as having access to your money is concerned. You are generally able to withdraw all or part of your money at any time.

For example, if an unforeseen expense arose a few years after your account based income stream commenced you would be normally able to access money from your investment account. Generally, there are no limits placed on how often you may make these types of withdrawals. You are also able to switch your money from one account based income stream to another if for any reason you want to change providers.

There is also some flexibility to match the income payments to your needs. At the beginning of each financial year you may select the level of income that you wish to draw, although the income selected must meet the minimum required level. The income payments will continue to be made to you until either you withdraw your money completely, or your investment account is exhausted.

The investment earnings added to your account will depend on the type of investment choices you make. Most account based income streams offer you a range of investment choices, some of which involve more risks than others.

One important point to note about account based income streams is that in most cases there are no guarantees given that you will have an income for your lifetime. The longevity of your income stream will depend on a number of factors, the most important being how much you draw out annually and what investment earnings you receive.

Account based income streams are very popular investments, with investments in the allocated pension variety representing around 80% of all money invested in income streams.

Income Payment Rules

There are a few rules associated with account based income streams and the income payments you receive. Each year the total annual payments (income and/or capital) must be above a minimum limit.

A set of factors, called Percentage Factors (or PFs), are used to work out the minimum annual payment limit each year.

To calculate the minimum level, your investment account balance at 1 July each year is multiplied by the appropriate PFs, and the result is rounded to the nearest $10.

This calculation then sets a lower limit to the annual payments for that financial year. Subject to this limit, you are free to choose the preferred level and frequency of income payments for the year, and there is no maximum level.

The following table provides PFs for a selection of ages:

Age at 1 July	Min PF
Under 65	4%
65 to 74	5%
75 to 79	6%
80 to 84	7%
85 to 89	9%
90 to 94	11%
95 and over	14%

Extract of schedule 7 of the SIS Regulations (1994)

Unlike life expectancies, PFs are the same for males and females of the same age.

Let's see how they work in practice.

in Real life...

Jack is aged 64 and is single. He invests $100,000 in an account based income stream on 1 July. From the above table we can see that his minimum PF is 4%. When Jack works out his minimum annual payment he will multiply $100,000 by 4%: $100,000 X 4% = $4,000 So Jack can draw an income of anywhere above $4,000. This limit applies for that financial year. So what happens each year? Each year the provider of Jack's account based income stream will do a similar calculation and let Jack know what his new limit is. Assume that a year has gone by and Jack, now age 65, has $99,000 in his account. At age 65 his PFs is 5%. The new calculation will be: Minimum payment $99,000 X 5% = $4,950 Jack can make a new income nomination at or above this limit for the financial year and this procedure is repeated each year.

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How does my investment account value change?

Your account value will vary regularly. It will go down in value when you draw an income payment and increase when investment earnings are added to your account. The following example will provide an insight into what happens over time.

Let's revisit Jack from the previous example. He was 64 when he started his account based income stream.

We'll assume Jack received an income of $7,000 in his first year (which was above his minimum). Each year Jack increases the income amount by 3% per annum. We'll assume that Jack is able to earn 6.5% per annum on his money after fees.

The following table shows Jack's annual income, his annual minimum payment and the movement in his investment account over time. Remember that investment returns can vary significantly from time to time and may even be negative.

Age	Jack's investment account balance at start of year	Investment earnings at 6.5% per annum	Jack's income payment each year	Minimum income each year	Jack's investment account balance at end of year
64	100,000	6,500	7,000	4,000	99,500
65	99,500	6,468	7,210	4,970	98,758
66	98,758	6,419	7,426	4,940	97,750
67	97,750	6,354	7,649	4,890	96,455
68	96,455	6,270	7,879	4,820	94,846
69	94,846	6,165	8,115	4,740	92,896
70	92,896	6,038	8,358	4,640	90,576
71	90,576	5,887	8,609	4,530	87,854
72	87,854	5,711	8,867	4,400	84,698
73	84,698	5,505	9,133	4,230	81,070
74	81,070	5,270	9,407	4,050	76,932
75	76,932	5,001	9,690	4,610	72,243
76	72,243	4,696	9,980	4,330	66,958
77	66,958	4,352	10,280	4,020	61,031
78	61,031	3,967	10,588	3,660	54,409
79	54,409	3,537	10,906	3,260	47,040
80	47,040	3,058	11,233	3,290	38,865
81	38,865	2,526	11,570	2,720	29,821
82	29,821	1,938	11,917	2,087	19,843
83	19,843	1,290	12,275	1,400	8,858
84	8,858	576	9,433	n/a	0

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Investment choices

So let's have a look at the typical investment choices which you may encounter within allocated income streams.

Capital Guaranteed

The term "capital guaranteed" generally means that 100% of the money you invest is guaranteed by the provider to be returned to you at a future date together with any earnings. The guarantee may not cover fees which are deducted from your initial investment. The term is often confused with investments where the interest rate on the investment is guaranteed but the capital isn't. In many cases, both the capital and the interest are guaranteed. You need to establish what the guarantee refers to - it's not something you can make assumptions about.

Capital Secure

This choice is usually for short term or very security conscious investors. This investment choice generally does not involve the giving of guarantees in relation to your capital. It also generally does not involve any guarantees in relation to the interest or investment earnings on your money. Instead, this choice usually refers to a conservative style of investing. A capital secure investment will generally hold a high proportion of its money in cash, short term money market securities, government and bank-backed securities.

The investment return on a capital secure choice will generally track short term interest rates. While the investments held within this investment choice are highly secure, you are not usually immune from losing part of your capital as a result of adverse investment markets - although it is highly unlikely that this would occur.

Capital Stable

This choice is for investors who are looking for a relatively stable investment and who are comfortable accepting short term fluctuations in investment returns.

There is no set definition of a capital stable investment choice. When investment managers refer to short term fluctuations in returns they usually mean that there may be some short periods where returns are negative. However, they generally would not expect to have a negative return over any 12 month period. This doesn't mean that it can't happen, it is simply not usual or expected.

The investments held in capital stable choices vary depending on the views of each manager. As a rule of thumb you would not expect to see more than 25% - 30% of the total investments in shares (Australian or International) and property. These investments' aim is to produce a relatively stable pattern of returns by limiting the exposure to investments which fluctuate more in value.

Managed or Balanced

This choice is suited to investors who want higher returns over the medium to long term. To use this investment choice you must be prepared to accept moderate fluctuations in returns over the shorter term.

With this choice, it is possible that you may experience negative returns over a 12 month period. The chance of having two consecutive years of negative returns is however quite slim. If you are considering this choice, you should not be a short term investor. As a guide, you should be looking at your investment over a 3 to 7 year time frame.

The underlying investments are generally spread over the full range of assets, including Australian Shares, fixed interest investments, cash, property and overseas investments. The percentages allocated to each area vary considerably between investment managers. Usually you would not expect to see more than 60% of the total investments in the areas of shares and property.

Growth

This choice has many similarities to the managed choice in that investments are usually spread over all types of investments. It is also similar in that you would need to have an investment time frame of 3 to 7 years. It is not the choice for short term investors or investors who are not tolerant to market fluctuations.

The main difference is that 'growth' choices may have more invested in the growth areas of shares and property than 'managed' choices.

Australian Shares

Some allocated income streams have a wide range of choices, which include investing in single investment categories such as Australian shares.

If you were to select a category such as Australian shares, you would have that part of your money exposed to the Australian sharemarket. With this exposure comes the volatility associated with investing in shares and the possibility of significant fluctuations in your investment returns.

As with the growth and managed choices you need to have a minimum investment time frame of at least 3 years, but more probably 5 years.

International Shares

This is similar to the Australian share choice except that the investments are shares in overseas companies. Most international share choices will have shares in most economic regions. You may see the total investments split between North America, Europe, Japan and South East Asia. The proportion allocated to each region will depend on the manager's views on how that region will fare in the future. It may also depend on the level of opportunities the manager sees in companies within that region. With international share investments, there is an added risk of currency fluctuation. This risk must be considered before making investments in this sector.

As with the Australian shares choice, you should have a minimum time frame of 3 to 5 years and be prepared to accept a higher level of volatility with your investments.

Property Securities

Some allocated income streams offer a specialist property choice. The underlying investments of this choice are usually listed property trusts, which are involved in the residential, office and industrial property markets. These trusts own the properties, lease them to a variety of tenants, and pass the income (less costs) from the buildings back to the investor.

This choice carries risk in that this part of your money would be fully exposed to the property markets. You should therefore look at this option on the basis of a long term investment and have a minimum 3 to 5 year time frame.

Australian Fixed Interest

Just as you can invest in shares or property, you can also invest in a specialist fixed interest choice. The underlying investments are usually government and semi- government bonds, and other high quality fixed interest securities issued by Australian companies.

Other Choices

Most of the choices available are outlined above. There are others which do not fit the descriptions above and some which go by a different name, but are very similar to the choices previously described.

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Account Based Market Linked Income Streams

Another type of account based income stream is a Market linked pension or annuity. They are sometimes referred to as 'term allocated pensions' or (TAPs).

When you are considering a market linked income stream you should be aware that you can only use 'superannuation money' to invest in them.

Selecting the term for your income

With a market linked income stream the income payments are paid for a fixed term. The duration of the term depends on when the income stream commences and your age at that time.

For a market linked income stream that commences before 20 September 2007, the term may be determined broadly by reference to your life expectancy at the commencement of the income stream. A table of current average life expectancies is shown earlier. You can choose a term anywhere between the following minimum and maximum terms:

Minimum Term - the income stream must be payable for a minimum fixed term equal to your life expectancy (rounded up). For a male of 65 the life expectancy is 17.7 years and hence an 18 year term would be relevant.

Maximum Term - the income stream must be payable for a term equal to the period from the commencement day of the income stream until the primary beneficiary reaches age 100. For a male of 65 that is 35 years.

As you can see there is a wide range between the minimum and maximum terms in this case.

In some less common circumstances it might be possible to use a different method of working out the term. This only applies where the income stream is set up so that on death the income payments must revert automatically to a spouse and the spouse has a longer life expectancy. This is referred to as a 'reversionary' income stream.

The term can be between the following ranges:

• a minimum term equal to the longer life expectancy of the reversionary spouse at commencement; and
• a maximum term equal to the period from the commencement day of the income stream until the spouse reaches age 100.

This option can only be used to provide access to a longer term.

Term Example - Selecting your term

James is age 65 and his wife Helen is aged 60. If James wants to acquire a Term Allocated Pension that reverts to Helen on his death, he can select a term for his pension of between:

• 18 and 35 years (based on the term for a 65 year old male); or
• 26 and 40 years (based on the longest term for a 60 year old female).

If James does not want to nominate Helen as a reversionary pensioner he can only choose a term between 18 and 35 years.

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Access to your money

Unlike other Account Based income streams, market linked income streams are a lot less flexible when it comes to accessing your capital investment.

Generally, most market linked income streams are 'non-commutable'. This simply means that, except in very limited circumstances, the capital you invest in them is not accessible at any time. Because of this restriction on accessing your money you should not, as a general rule, invest all of your money in them. You should keep part of your money in other investments where you have access or you could use some part of your money to purchase an allocated income stream. By doing so you will have the ability to meet unexpected lump sum expenses.

If you select a term based on your spouse's life expectancy, in the event of your death the market linked income stream must be paid to your spouse for the remaining term. Your spouse cannot convert the pension into a cash lump sum at your death.

Market Linked Income Streams commencing on or after 20 September 2007

In some cases, after 20 September 2007 you can purchase a market linked income stream still provided the fixed term is chosen such that the minimum annual payment (as determined by applying the relevant percentage factor) is met each year. The factors are the same as those listed for other account based income streams.

A market linked income stream can only be purchased under these rules with the rollover of a superannuation benefit from an existing complying lifetime, fixed term or market linked income stream.

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Income Payment Rules

So once you have chosen your term between the minimum and maximum, the income level for a market linked product can be determined for the first year. To work this out you take the purchase price of the income stream and divide it by a factor. The pension factors used are as follows:

Term	Payment Factors	Term	Payment Factors
50	23.46	25	16.48
49	23.28	24	16.06
48	23.09	23	15.62
47	22.90	22	15.17
46	22.70	21	14.70
45	22.50	20	14.21
44	22.28	19	13.71
43	22.06	18	13.19
42	21.83	17	12.65
41	21.60	16	12.09
40	21.36	15	11.52
39	21.10	14	10.92
38	20.84	13	10.30
37	20.57	12	9.66
36	20.29	11	9.00
35	20.00	10	8.32
34	19.70	9	7.61
33	19.39	8	6.87
32	19.07	7	6.11
31	18.74	6	5.33
30	18.39	5	4.52
29	18.04	4	3.67
28	17.67	3	2.80
27	17.29	2	1.90
26	16.89	1	1.00

So for the male of 65 who had a maximum term of 35 years and who chose to use the maximum term, you would take the purchase price of say $100,000 and divide it by 20.00. The income stream payment in the first year would be $5,000.

To allow some flexibility in the payments from a market linked pension you can select an actual annual income payment which is within 10% either side of the calculated figure. In this case it would be: $4,500 (90% of $5,000) or $5,500 (110% of $5,000).

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What happens each year?

Each year, the account balance is divided by the factor applicable to the remaining term. So if the account had remained at the same value in 12 months, the new income stream would be calculated by dividing $100,000 by 19.70, giving an income for the next year of $5,076

And to find the limits:

Minimum Income Limit	Maximum Income Limit
(0.9 x $100,000) ÷ 19.70	(1.1 x $100,000) ÷ 19.7
=$5,076 x 0.9	=$5,076 x 1.1
= $4,570	= $5,580

(Minimum income figures are rounded to the nearest $10)

How does my investment account value change?

Your market linked investment account value will vary regularly. It will go down in value when you draw an income payment and increase when investment earnings are added to your account. The following example will provide an insight into what happens over time.

Let's take Louise and Jon. Louise is age 71 and Jon is 65. They are both enjoying good health. Louise has $250,000 of superannuation money and invests this in a market linked pension on 1 July. They have other investments which can be cashed for any lump sum needs they may have.

Jon has a life expectancy of 17.7 years and Louise 16.29 years. Louise could therefore choose a term of between 17 and 29 years based on her life expectancy only. As Jon has the longer life expectancy, the pension may be set up on a reversionary basis (i.e. the income payments are automatically directed to Jon upon Louise's death). As Jon is 65 the maximum term could be extended to 35 years.

We'll assume that Louise selected a 30 year term. The factor for a 30 year term is 18.39. The income is $250,000 divided by 18.39, or $13,594. The income range for year 1 is as follows:

Minimum Income Limit	Maximum Income Limit
(0.9 x $250,000) ÷ 18.39	(1.1 x $250,000) ÷ 18.39
=$13,594 x 0.9	=$13,594 x 1.1
= $12,230	= $14,950

Louise selects $13,594 as the starting point and each year expects to use the calculated income amount without adjustment. We'll assume that Louise is able to earn 6.5% on her money after fees.

 

The following table shows Louise's annual income, her income range and the movement of her investment account over time.

Age	Louise's account balance at start of year	Investment earnings at 6.5% per annum	Minimum income each year	Louise's income each year	Maximum income each year	Louise's account balance at end of year
71	250,000	16,250	12,235	13,594	14,954	252,656
72	252,656	16,423	12,605	14,005	15,406	255,073
73	255,073	16,580	12,992	14,435	15,879	257,217
74	257,217	16,719	13,389	14,877	16,364	259,060
75	259,060	16,839	13,804	15,338	16,872	260,561
76	260,561	16,936	14,230	15,811	17,392	261,686
77	261,686	17,010	14,665	16,294	17,924	262,402
78	262,402	17,056	15,119	16,799	18,479	262,659
79	262,659	17,073	15,583	17,314	19,046	262,417
80	262,417	17,057	16,066	17,852	19,637	261,623
81	261,623	17,005	16,570	18,411	20,252	260,217
82	260,217	16,914	17,082	18,980	20,878	258,151
83	258,151	16,780	17,615	19,572	21,529	255,359
84	255,359	16,598	18,168	20,186	22,205	251,771
85	251,771	16,365	18,742	20,825	22,907	247,311
86	247,311	16,075	19,321	21,486	23,615	241,919
87	241,919	15,725	19,938	22,154	24,369	235,490
88	235,490	15,307	20,577	22,863	25,149	227,933
89	227,933	14,816	21,236	23,596	25,955	219,153
90	219,153	14,245	21,915	24,350	26,785	209,048
91	209,048	13,588	22,613	25,126	27,639	197,510
92	197,510	12,838	23,359	25,954	28,549	184,394
93	184,394	11,986	24,156	26,841	29,525	169,539
94	169,539	11,020	24,973	27,748	30,523	152,812
95	152,812	9,933	25,803	28,670	31,537	134,074
96	134,074	8,715	26,696	29,662	32,629	113,127
97	113,127	7,353	27,742	30,825	33,907	89,655
98	89,655	5,828	28,818	32,020	35,222	63,463
99	63,463	4,125	30,061	33,402	36,742	34,187
100	34,187	2,222	30,768	36,409	37,605	0

From the table you will note that Louise's account balance increases each year until age 79, when the pension then being drawn is greater than the investment earnings. After age 79 the income is increasing and the account balance is decreasing. In the last year, the balance of Louise's account balance is drawn out.

Louise could have elected to take a slightly lower income each year (using the 90% rule) however this generally has the effect of increasing the income in later years.

If Louise was able to generate better than a 6.5% per annum return, then this would have the effect of producing higher income for her over the 30 year term. Another option for Louise would be to examine all of the investment options her market linked pension offered to see whether she was using the most suitable option to boost her investment earnings.

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Are there fees and charges?

There are charges that usually apply to account based income stream investments. These may include initial fees which apply to your investment and ongoing fees. Ongoing fees are usually a percentage of your investment account balance each year.

The best way to evaluate the ongoing fees that apply to your investment account is to refer to the providers Product Disclosure Statement (PDS). In the PDS the provider must show worked examples of the total costs that apply in certain circumstances. The PDS will also detail all fees, commissions and brokerage payable to a financial adviser.

What happens when you die with an account based income stream?

A key part of retirement planning is estate planning. When you deal with account based income streams, there are several estate planning options which you need to consider before you invest.

If your affairs are complicated you may also need some legal advice.

There are generally three estate planning options available but not all providers or super funds provide all of the options.

Reversionary Income

It is possible to set up an account based income stream so that, on death of the purchaser, an income will continue automatically to a spouse or child (in certain cases). This does not generally prevent a spouse or child from converting the income into a lump sum (by using the cash out option) at a later date.

If you purchase a reversionary market linked pension, then upon your death the pension will continue to be paid to your spouse for the remaining term. Your spouse cannot convert the pension into a cash lump sum when you die.

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Lump Sum

The account based income stream can be set up so that, on death of the purchaser, a spouse or child would receive the balance of the investment account as a lump sum.

Flexible Option

With this option, on death of the purchaser, a spouse or child has the choice of whether to continue to receive an income stream or take a lump sum.

The choice of option depends on your personal circumstances and how you want your estate to be dealt with. There can be different taxation outcomes for each option, depending on your circumstances.

Advantages and disadvantages

As with any investment there are advantages and disadvantages. Some of the major ones for account based income streams are shown in the following table.

Advantages and Disadvantages of Account Based Income Streams

Advantages	Disadvantages
You have significant flexibility in the income you draw from year to year.	You do not have a guarantee that the regular income payments will continue for your lifetime or any fixed term.
You generally have access to your money at all times.	You may be subject to unfavourable fluctuations in investment markets.
You receive a regular income payment.	You need to continue to be involved in the decision making process each year.
You usually have a range of investment options to choose from.	You can only use 'superannuation money' as the purchase price.
Your family, beneficiaries, or estate will receive the investment account balance on your death.

Types of Income Streams - Non Account Based

All other income streams are categorised as being non account based which simply means that you don't have an account balance in the fund. Instead what you do is exchange an amount of money for a regular income which is usually guaranteed to be payable to you.

The features of these income streams can vary considerably and they are commonly referred to as 'lifetime income streams' or 'fixed term income streams'.

Lifetime Income Streams

Lifetime income streams are the most secure and certain variety of income stream available.

There are two types of these - lifetime pensions and lifetime annuities. A lifetime pension is provided from a superannuation fund, whereas a lifetime annuity is an annuity contract issued by a life insurance company. Apart from this difference they are almost identical in features.

You can only use 'superannuation money' to invest in lifetime pensions. Any savings you have outside superannuation would need to be contributed to a superannuation fund prior to investing in a lifetime income stream. Anyone can contribute to superannuation prior to age 65 without satisfying any eligibility rules. After age 65, eligibility conditions need to be met. To contribute to a fund you need to have worked at least 40 hours within a consecutive 30 day period in the financial year in which the contribution is made.

On the other hand, lifetime annuities can accept any type of savings - superannuation or non-superannuation based, including for example, deposits directly from your own bank account.

How do they work?

Lifetime income streams, as the name suggests, are payable for the investor's lifetime regardless of the age of the person. This means that you would be paid income payments, at least annually, for the rest of your life. So there is no risk of outliving this type of income stream.

In some cases it may also be possible to have income payments made for the lifetime of another person, usually a spouse. This is commonly referred to as a 'reversionary' income stream.

Where the lifetime income stream is purchased (as distinct from simply receiving the payments from your superannuation fund) you exchange a sum of money for a guaranteed series of future income payments. By doing so, you transfer the investment risk to the provider.

Before you purchase a lifetime income stream, you will receive a quotation of the payments that you would expect to receive in the future. In this way you are able to know where you stand before you commit your retirement savings. You simply nominate the features that you want and then the provider will tell you how much they will pay you each year after taking into account your selections.

The annual amount of income offered will vary between providers. You, or your financial adviser can compare what is on offer through quotations. You can also look at tables in financial magazines and journals, which are prepared by independent sources.

What are the features?

Payments - you get to choose how often you want your payments. They must be at least annually and you can usually choose from monthly, quarterly or half yearly.

Income increases - as this type of income stream may continue for what you hope is a very long period of time, you may also set up the income so that it increases annually with movements in inflation or some other fixed rate of increase. In this way your income can move with general price increases.

Reversionary income and percentage - when you invest in a lifetime income stream you may want an income to continue to a spouse on your death. If the income stream was purchased with 'superannuation money', the reversionary can generally only be your spouse or a dependant child. The income which becomes payable to that person is referred to as a 'reversionary' income. Usually the reversionary income will be lower than the original income that was supporting, or assisting to support, two people. When the income reduces on death, the amount of the reversionary income is referred to as the reversionary percentage. This can be up to 100% of the income which was payable before death but is often is set around 60 - 70%. If this option is selected a spouse, for example, could receive 60% of the income that was paid at the time of death and this would then be payable for the remaining lifetime of the spouse. Any indexation will continue on the reversionary income.

Guarantee periods - you can also consider some form of income protection by selecting what is generally referred to as a 'guarantee period' with your lifetime pension or annuity. Should you (and your spouse if the income has been set up to be payable to both of you) die within the guarantee period, income payments may continue to another beneficiary until the end of the guarantee period. The most common guarantee period selected in the past has been 10 years. Where the income stream is reversionary, you can select a guarantee period which is the longer of your life expectancy or your spouse's life expectancy but not greater than 20 years.

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Are there fees and charges?

Generally, no separate fees are charged. You should be aware that fees and commissions are usually factored into the annual amount of income offered. If a commission or fee is payable for your purchase of a particular income stream, such as to a financial planner, this should be disclosed to you.

in Real life...

Ross is aged 66 and Sheila is aged 67. They have $80,000 to invest, and after takiadvice, decide to invest in a lifetime income stream. They go through the optioavailable and decide as follows: Income Payments - to be received monthly Income increases - all income payments to be indexed each year by 2% per annum. Reversionary income and percentage - in the event of Ross's death, payments will continue to Sheila (assuming she is still alive) for her lifetime. If Ross were to pdecease Sheila, they think that she would need 70% of the income they were receiving as a couple given that many of their normal living expenses are fixed. Guarantee Period - they decide on a 10 year guarantee period so that if they both died within the first 10 years of the income payments commencing, payments for the balance of the 10 year period would be available to a beneficiary or estate. When they commence the income stream they receive $5,443 per annum. This amount increases each year by 2% per annum. The income payments continue foyears, at which stage the payments are $6,130 per annum. Then unfortunately Ross dies. Sheila starts to receive income payments of $4,291, being 70% of the payments they were receiving at the time of Ross's death. The income payments continue to Sheila for her lifetime and she lives to age 86. Alond the way, her income payments have been indexed each year by 2%.

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Access to cash

Unlike the account based variety of income streams, lifetime income streams are a lot less flexible when it comes to accessing your capital investment.

Generally, most lifetime income streams are 'non -commutable'. This simply means that, except in very limited circumstances, the capital you invest in them is not accessible at any time. If you need some money, for example to carry out house repairs, you cannot generally ask your lifetime income stream provider for this money.

Because of this restriction on accessing your money you should not, as a general rule, invest all of your money in them. You should keep part of your money in other investments which allow for access to your capital, or also invest some of your money in more flexible account based income streams where you can access your capital. By doing so you will have the ability to meet unexpected lump sum expenses.

Advantages and Disadvantages

Let's look at the major advantages and disadvantages of this variety of income stream.

Advantages and Disadvantages of Lifetime Income Streams

Advantages	Disadvantages
They provide a guaranteed level of income for your lifetime and possibly that of a spouse also.	From an income viewpoint they are inflexible, as you do not get to choose a different income level at any time.
After you invest you do not have to worry about what is happening in investment markets. If the sharemarket drops or interest rates decrease, your income will remain at the level you commenced with, subject to any indexation increases.	You cannot generally access any of the money you invest at any time.
Once you have made your initial choices these products are very simple - you receive a regular income for the rest of your life.	You may 'lose' some capital in the event of premature death.
You may 'gain' significantly if you live a long time.	If investment markets boom or interest rates increase, you do not participate by way of additional income, as your income payments are locked in at commencement.

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Fixed Term Income Streams

The 'fixed term' variety of non account based income streams offer security and certainty and also provide you with more options than other guaranteed income streams.

A fixed term income stream is simply one that is payable for a set period of time. Typically, this can be for any period of time, from 1 year to around 35 years. Unlike lifetime income streams, they will not continue to be paid for your lifetime or the lifetime of anyone else.

When you purchase this variety you exchange a sum of money for a guaranteed series of future income payments.

There are two types of fixed term income streams - fixed term pensions and fixed term annuities. A fixed term pension is provided from a superannuation fund, whereas a fixed term annuity is an annuity contract issued by a life insurance company. Apart from this difference they are almost identical in features.

As with other types of pensions, you can only use 'superannuation money' to invest in a fixed term pension whereas a fixed term annuity can be purchased either with superannuation or ordinary savings.

As for lifetime income streams, before you purchase a fixed term income stream the payments you would receive into the future will be quoted to you. In this way you know where you stand before you commit your retirement savings. Also, there are a number of options that are available at the time of investing.

The annual amount of income offered will vary between providers. You, or your financial adviser, can compare what is on offer through quotations.

in Real life...

Margaret had recently been made redundant from her employment at the age of 58. She had accumulated a reasonable amount in the way of super benefits over her working career and was in a position to be able to keep these in a super fund for at least the next five years. She was due to receive a redundancy package from her employer and thought that it would be good idea if she could invest this money to produce an income for a few years, as she was uncertain of her employment prospects. She had secured a part-time job adn was hoping that it would continue for about the next five years but was not sure. She wanted to supplement this income over the same period. She decided to invest her after tax retrenchment package in a 5 year fixed term annuity. She chose the option of not receiving her capital back at the end of the term and with her $50,000 she received an income of $11,260* per annum over the 5 year period. She anticipated that with the part-time work she would have an adequateincome for the next 5 years. She would then review her options and decide how best tinvest her accumulated super money. * Note that fixed term income stream rates will vary from time to time with movements in interest rates and investment markets.

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What are the options?

Payments - you get to choose how often you want your payments. Thye must be made at least annually and you can also usually choose from monthly, quarterly or half yearly.

Income increases - as this type of income stream may continue for any set period of time, you can also set up the income so that it increases annually with some fixed rate of increase. Usually fixed term incomes do not provide direct links to inflation increases.

Residual Capital Value - this is a technical name that simply refers to the amount of money you get back at the end of the term. Fixed term income streams, unlike most othvarieties, commonly pay part of your investment back at the end of the fixed term. The repayment can be as high as 100% of your original investment, or you may choose to have none(ie. 0%) of your investment returned at the end of the fixed term.

Access to cash

Fixed term income streams are inflexiable when it comes to accessing your invested capital on an ongoing basis.

While generally most fixed term income streams are commutable (ie. accessible) to soextent, there may be penalties involved for early cashing of benefits. This means that except in very limited circumstances, it is preferred not to plan to access youir capital at any time prior to the end of the term.

Because of this restriction on immediate access to your money, you should not, as a general rule invest all of your money in them. An exception to this may be where yoinvesting for a short period of time and at the end of the period, you receive all or a substantial part of your original investment back ( by way of a residual capital value).

What happens when you die?

With these types of income streams you have the comfort of knowing that the income stream will be payable for the fixed period. If you die within the fixed period, the payments can continue to a beneficiary or your estate, or a lump sum may be payable.

These types of income streams ensure that there is no loss of the agreed income payments on death.

You can set up a fixed term income stream so that on your death, the income may continue to your spouse. This income is referred to as a reversionary income. The reversionary income would then be payable for the remaining original term. Alternatively, the income can be cashed in and a lump sum paid to a beneficiary or your estate.

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Are there fees and charges?

Generally, no separate fees are charged. You should be aware that fees and commissions are usually factored into the annual amount of income offered. If a commission or fee is payable for your purchase of a particular income stream, such as to a financial planner, this should be disclosed to you.

Advantages and Disadvantages

As these income streams may vary in length of term, the advantages and disadvantages to individual investors may also vary as they can be used for different reasons. For example, they may be used as a short term parking investment where income payments are derived and capital is returned at the end of the term. Alternatively, they could be used for a very long term (eg. 35 years) and provide no capital value at the end of the term.

The major advantages and disadvantages that apply to all investors in these income streams are:

Advantages and Disadvantages of Fixed Term Income Streams

Advantages	Disadvantages
The income payments are guaranteed to be payable for the fixed term thereby offering a lot in the way of security.	From an income viewpoint they are inflexible, as you do not get to choose a different income level at any time.
They are flexible in that you can nominate how much of your original investment you want back at the end of the fixed term.	You generally cannot easily access all or part of the money you invest.
A regular income for the chosen period of years.	If investment markets boom or interest rates increase, you do not participate by way of additional income, as your income payments are locked in at commencement.
Once you invest you do not have to worry about what is happening in investment markets. If the sharemarket drops or interest rates decrease, your income will remain at the level you commenced with, subject to any indexation increases.	If capital is returned to you at the end of the term, you will need to consider new investment decisions.
Your family, beneficiaries or estate will receive the remaining agreed income payments on your death or a lump sum.

Comparison of different types of income stream products

 

The following table provides a summary of the different types of income stream products and shows how their features vary. The non-account based products in the following table are assumed to be complying products for social security purposes.

Features	Account based Income streams	Account Based Market Linked income streams1	Non Account based Lifetime income streams2	Non Account based Fixed Term income streams3
Account based	Yes	Yes	No	No
Insurance company based	No	No	Yes	Yes
Annual income payments are guaranteed	No	No	Yes	Yes
Investment choice	Yes	Yes	No	No
Fixed term	No	Yes	No	Yes
Access to capital	Yes	Â	No	No
Recipient can vary annual income received	Yes	Yes	No	No
Residual capital value allowed	N/A	No	No	No
Death benefit payable	Yes	Yes	Possible4	Yes
Asset test concession (if purchased)5: * pre-20 Sept 2004	N/A	N/A	100%	100%
* post- 20 Sept 2004	N/A	50%	50%	50%
Income tested	Yes	Yes	Yes	Yes

Investing in Income Streams to suit your needs

Trying to match the investment in income streams to your income needs can require some extra thought. In the 'In Real Life' cases used we assume that investment returns will be consistent over the life of the income stream, whereas in practice they generally vary each year. Also, the cases assume that where income is to increase each year, it does so in a consistent fashion. In practice, our retirement income needs will vary throughout retirement years.

Working out income needs throughout retirement is a very personal thing and it is quite difficult to generalise about income needs.

Some people take the view that they should have higher income in the earlier years of retirement when they are healthy and active. Hence, with greater activities, including travel, expenses may be higher.

Others take the view that they should try to limit living expenses in earlier years to build up capital for later in retirement and also to provide for contingencies such as health costs.

There is no right or wrong answer to this. There may be phases of retirement where your income needs will vary. What you do is to try to design your income stream investments so that the right amount of income is produced at the right times.

When we look at the different income streams from an income flexibility viewpoint we can see how the features are different.

Type of Income Stream	Income Flexibility
Account Based (Allocated)	Good flexibility with minimum income catering for a wide range of income levels. Capital will be used up more quickly if higher levels of income are taken and preserved for longer if minimum taken.
Account Based (Market Linked)	Limited income flexibility (+ 10% or - 10%) but you know that income will be payable for the term selected.
Non Account Based (Lifetime)	Very little flexibility apart from the % level of indexation of payments each year but you know that payments are payable for life.
Non Account Based (Fixed Term)	Very little income flexibility but again you know that income will be payable for the term selected. However the term selected could be shorter thereby creating higher payments for living expenses.

So if you wanted to produce a higher income in the earlier years and have a more stable but longer income in later years, you could perhaps invest in an account based allocated pension initially and switch to an account based market linked income stream later.

Alternatively, you could invest in an account based income stream now and draw income at a level closer to the minimum and use a smaller part of your money to invest in a short term fixed term income stream to provide additional funds for living expenses in the shorter term.

1. Income stream must meet requirements in s.9BA of Social Security Act 1991.
2. Income stream must meet requirements in s.9A of Social Security Act 1991.
3. Income stream must meet requirements in s.9B of Social Security Act 1991.
4. Death benefits are payable only where a guarantee period exists and all beneficiaries die within the guarantee period.
5. From 20 September 2007, all new income streams will generally be 100% assets tested

What are the Tax Rules?

The tax rules for your retirement income stream will depend on your age and the type of fund that is paying you the income stream.

Usually Tax Free

From 1 July 2007, if you are over age 60, the income payments you receive will be tax free if they are paid from a taxed super source or fund. Most retirement income streams are payable from taxed super funds - this means funds that are subject to tax on their income along the way. All account based income streams and most publicly available non account based income streams are payable from a taxed source (or fund).

The tax free status of your income stream applies regardless of how much income you derive. So theoretically, if you invested in an account based product you draw the whole amount out and not pay any tax on the amount. Also, because the amount is tax free you don't even have to include it in your tax return.

Payments under Age 60

From 1 July 2007, the taxable income from a superannuation income stream under age 60 will be determined by applying a 'proportioning rule'.

This tax treatment between preservation age and age 60 is summarised in the table below.

Source of Income Stream Income	Assessable Component of Income
Proportion representing the Tax Free Component in the benefit	Nil - (effectively tax free income)
Proportion representing the Taxable Component in the benefit	Fully assessable - (subject to tax at the recipient's marginal tax rates although a 15% tax-offset may apply over age 55)

• Note income streams from an untaxed source do not receive any tax offset under age 60.
• The Tax Free component of your superannuation benefit will generally comprise personal after-tax or undeducted contributions. In some case, certain other amounts are also included in the Tax Free component of a benefit.

For superannuation income streams that commence on or after 1 July 2007, this new proportioning rule involves a two-step process:

• Step 1 - Determine the proportion of the total superannuation benefit that is the Tax Free Component at the commencement date; then
• Step 2 - Apply this calculated proportion to all future income (and capital) payments that are made from the superannuation income stream.

Example

Sally, aged 57, purchases a superannuation income stream on 1 July 2007 with her total superannuation benefit of $500,000. Her income stream will pay her $2,000 per month. This superannuation benefit consists of the following tax components:

• Tax Free Component = $200,000; and
• Taxable Component = $300,000.

Using the proportioning rule, we can determine that the amount of income she will be able to receive on a tax free basis is:

• Step 1 The proportion of Sally's superannuation benefit that is the Tax Free Component
  = $200,000/$500,000 = 40%

• Step 2 The amount of income able to be received on a tax free basis
  = 40% x $2,000 = $800 per month

Therefore the Taxable Component of Sally's $2,000 monthly income payment is $1,200.

Will I get a tax offset?

A tax offset of 15% is available to recipients who are aged less than 60 (but over preservation age) for income streams paid from taxed super funds.

The offset is 15% of the gross pension or annuity payment less the tax free portion where one exists. The following example explains the calculations:

The following example explains the calculations:

Â	$
Gross Pension or Annuity	20,000
Less Tax free amount	(4,000)
Assessable pension or Annuity	16,000
Tax on Assessable pension or Annuity (excluding Medicare levy)	1,500
Less Pension Offset @ 15% of $16,000	2,400
Tax Payable	NIL

*Note that the tax assessed in the above example has been simplified and there may be other taxation rebates applicable in many cases. Further, Medicare levy may be payable.

In this example, no tax would be payable on this part of the person's assessable income for the year and there would be an excess offset to use against any other tax payable.

Note. If we return to the previous example of Sally, she would be entitled to receive a tax offset of 15% x $1,200 = $180 per month since she is over age 55. From age 60, all of her income payments would be tax-free.

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Excess Offset Usage

An excess offset arises where the pension or annuity offset nullifies any tax that would otherwise be payable on pension or annuity payments and the offset is greater than the total tax payable.

It is possible in these situations to offset the excess amount against tax on any other income that the person has in that year. The excess offset cannot be carried forward to the next tax year if it is not used this year.

Working out tax (untaxed funds)

Income streams payable from untaxed funds (e.g. Commonwealth Superannuation Scheme) are generally known as 'defined benefit' super pensions. These types of pensions are usually similar to other lifetime income streams in that payments are generally made for your lifetime and in some cases, also the lifetime of your spouse.

With defined benefit super pensions, some part of your income stream payments may be considered to be tax free. The balance of any income payment will be considered assessable and hence taxable income.

The calculation of the 'tax free' amount depends upon a range of factors, including whether or not the income stream started before 1 July 2007 and whether or not you are age 60 or more. Generally, the tax free component will represent the total amount of any undeducted contributions that were made to your fund. These are contributions made to a fund where no tax deduction has been provided for the contributions. They are also referred to as contributions you make from after-tax dollars.

If you are aged 60 or over, generally you will be eligible to obtain a 10% tax offset on the amount of any taxable income payments you receive from a defined benefit pension.

Example

Mary is a 65 year old public servant who decides to retire in July 2007. Mary will receive an annual superannuation pension of $35,000 p.a. from her public sector super scheme.

Mary also found out that $5,000 of her pension income is considered to come from her personal after-tax contributions that she made prior to retirement (using the proportional method illustrated previously).

Since $5,000 of Mary's $35,000 pension is deemed to come from her after-tax income, she would only have taxable pension income of $30,000. The amount of $5,000 would be paid to Mary tax free.

Mary would also receive a tax offset of 10 per cent of $30,000 (or $3,000). This can be used to offset the amount of tax payable by Mary (depending on her circumstances).

Working out tax (non-super funds)

The tax treatment of income stream payments payable from annuities purchased with non super money is slightly different.

There are a few steps involved in working this out, and a few technical terms you need to know some more about.

Step 1 is to work out your Undeducted Purchase Price (UPP).

Where you have purchased your income stream with other private savings (not 'superannuation money') the UPP will be equal to the purchase price of your investment.

Step 2 To determine the tax free amount (its technical name is deductible amount), the undeducted purchase price is divided by the relevant number.

For income streams which are payable for a life the relevant number will be the life expectancy of the recipient. For income streams payable for a fixed term, the number of years it is payable for will be the relevant number.

For a single person, her or his life expectancy factor will be used. For couples, the longest life expectancy of the couple will be used where the income stream has been set up to continue to a spouse in the event of the death of the purchaser.

Step 3 Is there a residual capital value? If the income stream you invest in will pay you back part of your capital at the end of the term, then this must be taken into account in the calculation of the tax free part of your income stream. This does not usually apply for income streams payable from untaxed funds.

Step 4 Do the following calculation:

Tax free amount = UPP less residual capital value ÷ Relevant number

Now that we have looked at the theory, let's look at some real life examples.

Where the undeducted purchase price (UPP) component is say, $100,000, and a single life pension or annuity is purchased by a 65 year old male, the calculation is as follows:

$100,000 ÷ 17.7 = $5,650

This assumes there is no residual capital value involved.

In this case, $5,650 of the annual income payment will be tax free. Normal marginal tax rates will be applied to any income payment in excess of the annual deductible amount. There is no specific tax offset that applies for non-superannuation income streams.

Social Security Rules

Most investments are subject to means testing arrangements for social security pensions and allowances and Veterans' Affairs pensions.

Retirement income streams are no different and they are subject to means testing. However, they have their own specific rules for both the income and assets tests.

For the income test, special rules are applied to most income streams because the income stream payments you receive will generally include a return of part of your capital. So there needs to be a way of working out which bit is income and which is your capital. Generally, for the income test, it is only the income part which is counted under the income test.

For the assets test, all income streams are counted in some way except one category which receives a partial assets test exemption. As a general rule, only those income streams where your capital cannot be accessed receive a part exemption from the assets test.

Categories of Income Streams

The treatment of your income streams under the income and assets tests will differ depending upon:

• the characteristics of the income stream; and
• the duration over which income (and capital) is designed to be paid; and
• your age at the time of commencing the income stream.

What this means in practice is that income streams will be treated according to their features under social security rules. Income streams are classified into three separate categories for social security purposes as shown in the following table.

Category 1

Short Term Assets Tested

Characteristics: All income streams which are not Category 2 or 3 income streams (generally income streams of a fixed term of 5 years or less).

Income stream types included in this category Most non account based income streams which are for a fixed term of 5 years or less

Category 2

Long Term Assets Tested

Characteristics: Income streams that are payable for a fixed term in excess of 5 years, and all other income streams that do not meet the specific requirements of Category 3.

Income streams included in this category : all account based allocated income streams; fixed term income streams with terms of more than 5 years, and lifetime income streams that are not complying.

Category 3

Long Term Partially Assets Test Exempt

Characteristics: All non account based lifetime income streams that meet the general conditions below. Certain fixed term income streams that meet the following conditions as well as the general conditions below: Must be purchased at or over age pension age or service pension age (for jointly owned income streams, both recipients must meet this criterion); the term of the investment must be for a minimum term of at least the life expectancy of the purchaser; for reversionary fixed term income streams payable for at least life expectancy and market linked income streams the term of the investment cannot be more than the period to age 100, based on the longest period to age 100 of the purchaser and spouse. For market linked income streams, the income payments must be at least the annually determined minimum level. General conditions All Category 3 income streams must meet a number of conditions. The main ones are listed here. The income stream must: have at least annual payments fixed at the outset of the arrangement; have limits on the amount of indexation (increases) that can occur each year; not allow for decreases in income payments; convert all the purchase price to income payments; not be commutable (ie. you cannot cash it out) except in limited circumstances; not have a final capital payment (residual capital value) at the end of the term of the income stream. There are other characteristics that must be met (particularly if your income stream can be paid to another person on your death) and you should seek further information about this.

Income stream types included in this category Lifetime income streams which have all the required characteristics Fixed term income streams payable for life expectancy which have all the required characteristics Account based Market linked income streams which have all the required characteristics

The partially assets test exempt category of income streams will cease from 20 September 2007, meaning that there will not be any income streams purchased after that date that will benefits from a full or partial assets test exemption.

For certain income streams purchased prior to 20 September 2004, different rules applied and complying income streams received more generous assets test treatment than is currently the case.

How do the 'life expectancy' rules work in practice for income streams purchased before 20 September 2007?

To qualify as a complying income stream and hence receive more favourable assets test treatment, certain fixed term and market linked income streams must at least be payable for a term which is broadly equal to the life expectancy of the purchaser (rounded up to the nearest whole year). As we have seen there are other circumstances where the term can be up to the number of years to age 100. To illustrate this let's have a look at a couple of cases.

in Real life

Joe is age 72 and has an average life expectancy of 12.75. If he purchased a life expectancy income stream with no residual value that met the other conditions for a complying income stream, 50% of Joe's income stream value would be exempt from the assets test.

Elizabeth is aged 63 and has an average life expectancy of 22.85 years. If she purchased a market linked income stream with a term of at least 23 years and it met the other conditions for a complying income stream, 50% of Elizabeth's income stream value would be exempt from the assets test.

Bill is aged 66 and his spouse Julia is age 64. His life expectancy is 16.95 years and hers is 22 years. If they purchased a market linked income stream that: was established on a reversionary basis, and was for a term anywhere between 17 years (Bill's life expectancy) and 36 years (the term to 100 for Julia), and met the other conditions for a complying income stream then 50% of Bill's income stream value would be exempt from the assets test.

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What are the means testing rules?

The following table shows how each of the 3 categories of income streams are generally assessed for determining the income for the income test, and the asset value for the assets test.

Category	Income Test Rules	Assets Test Rules
Short Term Assets Tested	Subject to 'Deeming' and the deemed income is based on the assets test value (see below for 'deeming' rules).	Assets tested and there is a formula for working out the asset value (see below for details).
Long Term Assets Tested	The income stream payment is assessed but it is reduced by an amount of 'exempt income' (see below for details).	This category is assets tested. Where the income stream is account based it is the investment account balance which is counted. In any other case there is a formula for working out the asset value (see below for details).
Long Term Partially Assets Test Exempt	The income stream payment is assessed but it is reduced by an amount of 'exempt income' (see below for details).	This category receives a 50% assets test exemption provided it is purchased prior to 20 September 2007. In some cases, a 100% assets test exemption applies for complying income streams purchased prior to 20 September 2004.

How to work out the income and assets test values

Working out values for the income test

For category 2 and 3 income streams, the income stream payments will be treated as income. However part of that income will be exempt from the income test. To work out how much of the annual payment from the income stream will be assessed for social security purposes, use the following formula:

For category 2 income streams:
Annual Payment less [(Purchase Price - RCV) ÷ Relevant Number]

For category 3 income streams:
Annual Payment less [Purchase Price ÷ Relevant Number]

The relevant number is:

• For an income stream payable for a fixed number of years, that number of years.
• In all other cases the longest life expectancy of either the investor and/or the reversionary beneficiary (where specifically nominated).

Where an income stream is purchased on the basis that the income may be payable to a spouse or other person, or the investment is made jointly, the longest life expectancy (per the tables referred to earlier) of the couple is used in this calculation.

Note that the Purchase Price will be reduced by the total amount of any lump sum commutations made at any stage after commencement.

Defined Benefit Pensions

Defined benefit pensions have their own special income test calculations. The assessable income amount is calculated as:

Annual Payment less Deductible Amount (which is defined as per relevant tax calculations)

From 1 July 2007, the formula used to calculate deductible amount will change for new income streams and also for existing income streams when the recipient turns age 60. However, this method will still be used to assess the amount of income on an ongoing basis at any age.

in Real life

Category 2 Income Stream Alfonso is 66 years of age. He is single and has an average life expectancy of 16.9years. He invests $100,000 in an allocated income stream and he receives an incomeof $8,000 in the first year. When he works out his income for the income test he dothe following calculation: $8,000 - $100,000 ÷16.95 = $2,101 16.95 This means that of his $8,000 income payment, $2,101 is counted as income under the income test. If Alfonso invested in a 10 year fixed term income stream, which had no cash back at the end of the term (ie no residual value) and income payments of $13,500, he would work out his income as follows: $13,500 - $100,000 ÷10.00 = $3,500 10.00 This means that of his $13,500 income payment, $3,500 is counted as income under the income test.

Working out values for the assets test

For those non account based income streams which are subject to the assets test, there is a formula for working out an asset value. The reason there is a formula is because there is no clearly identifiable asset value once the income stream has been purchased and hence one needs to be calculated.

For account based income streams there is no need to work the asset value as this value will be the investment account balance.

To work out the asset value during the period of the income stream the following formula applies.

Purchase Price - [ [ (Purchase Price - RCV) ÷ Relevant Number] x Term Elapsed ]

The term elapsed is the number of years that have elapsed since the income stream commenced. In most cases the asset value is reduced six monthly in arrears (which means that the asset value equals the purchase price for the first 6 months). However, where the income payments are annual, the asset value decreases annually in arrears.

For lifetime income streams, this formula means that there will be no assessable asset value once the income has been paid for a term at least equal to the appropriate life expectancy of the person (or couple).

Defined Benefit Pensions

Defined benefit pensions have their own formula to calculate the amount of assessable asset values each year. In some cases, some of all of the asset value may be exempt where the defined benefit pension meets all of the required criteria to be a 'complying' pension for social security purposes.

in Real life

Category 2 Income Stream Take Alfonso from the previous example. He invested $100,000 in a 10 year fixed term income stream. We'll assume he receives his income payments monthly. After 6 months has passed Alfonso has his income stream assessed under the assets test. At that time the calculation of the asset value will be: = $100,000 - [ ((($100,000 - $0) ÷ 10) x 0.5 of a year) ] = $100,000 - $5,000 = $95,000 So for the second six months his asset value for the assets test will be $95,000. This figure will reduce every 6 months thereafter for the 10 year period.

Impact of 'deeming' for short term income streams

Under the income test, those income streams which are classified as short term (ie. 'category 1' income streams) will have their asset value (as calculated above) subject to the deeming rules. This means that 'deemed' income is assessed for the income stream. The actual income is not counted.

Under deeming, the values of all of your 'financial investments' are added together. Income on the total value is assessed at the rates in the table below. The actual income from these investments is not assessed. Financial investments include bank, building society and credit union deposits, cash, shares, fixed interest investments, managed investments and category 1 income streams.

Deeming rates are adjusted from time to time. The rates which apply at 1 July 2007 to financial investments, including short term category 1 income streams are:

Single Pensioner

Deeming Rate	Deeming Rate Threshold
3.5%	Up to $39,400
5.5%	Excess over $39,400

Pensioner Couple

Deeming Rate	Deeming Rate Threshold
3.5%	Up to $65,400
5.5%	Excess over $65,400

*These rates are subject to review by the Minister for Families, Community Services and Indigenous Affairs and may be varied from time to time.

Need more information about social security?

While this information contains a general outline of the social security rules, it does not include all of their details. If you need more information about social security rules, you could seek further information from a Centrelink Financial Information Service Officer.

Retirement Income Stream Estate Planning Issues

What issues are relevant for estate planning?

Inevitably, as we approach retirement or are already in retirement, we start to think more about family issues. Estate planning is the term that is generally given to planning your family affairs so that in the event of your death, your wishes are both clearly outlined and administered the way you intended them to be.

This includes considering issues such as:

• Do you wish to leave money to your estate, remembering your current needs?
• If you wish to leave money to others, how much is appropriate, given your level of assets and current needs?
• If you wish to leave money to others, how do you best direct money to them?

These are common questions and your requirements in these areas will no doubt vary over time.

Your Will

One of the key parts of estate planning is your Will. This is the document that sets out who you want your money to go to. Many people do not have a Will. If you die without a Will, State laws determine who gets the proceeds of your estate. For example, if you are married without children, your assets will pass automatically to your spouse. This may or may not agree with your wishes.

Anyone with experience in dealing with estates would strongly recommend that you have a current Will, as its existence will certainly assist any family members that you pre-decease. If you are part of an 'extended' family it is vital that you have a Will.

When you establish a Will you will also set out who is to be appointed as your executor or executors. This is the person or persons that you are entrusting with the job of looking after your affairs until your estate is distributed to your nominated beneficiaries. The selection of this person is an important decision. The person can be a member of your family, a friend - or for example, your solicitor or accountant.

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Income streams and your estate

• As your retirement income stream entitlements are part of your assets at the time of your death, it is important to consider these benefits as part of your estate planning.
• If you have a partner, usually the first issue to consider with income streams is whether you wish to have the income stream continue directly to them on your death. We have mentioned that it is possible to ensure that an income stream (usually referred to as a reversionary income) is payable to your partner in the event of your death. This is one of the important choices that you have to make when investing in, or commencing to receive, an income stream.

On the other hand, if you are single or you simply do not wish to set up a reversionary income stream, then you can consider nominating a dependant to receive any lump sum benefits payable on death.

There are different estate planning issues to consider, depending on the income stream selected and whether or not it is purchased with 'superannuation money' or other savings. This is one area where a financial planner can be of great assistance.

For example, where the trustee of the superannuation fund from which your pension was being paid decides to pay any death benefit to your nominated dependant(s), then this amount will not form part of your estate. The benefit will simply be paid from the superannuation fund directly to your nominated dependant(s).

In many cases, this would achieve the same result as not making a nomination and having the benefits become part of your estate. This is the case where your spouse is the recipient of any death benefits - either way you arrange it you will achieve the same result.

One advantage of making an appropriate nomination with your superannuation fund is that the trustee can elect to pay any benefits directly to your spouse rather than through your estate. This can avoid delays that can arise with the winding up of your estate or dying without a Will.

While the trustee of your superannuation fund is not bound to follow any specific nominations upon your death (unless you have lodged a binding nomination with the trustee), they will have regard to them when deciding to whom benefits are to be paid.

The following table summarises the options for nominating how your incomes stream benefits can be handled upon death:

Caption

Income Stream Type	Estate Planning Options	Is Death Benefit part of the Estate? (Yes/No)
Pension	Reversionary income Lump sum nomination Trustee decides to pay either income or lump sum	No No Yes or No (depends if nominations exist)
Annuity	No nomination Reversionary income Lump sum nomination No nomination	Yes or No (depends) No No Yes

*The above table assumes that a beneficiary exists at the time of death where a nomination is made, otherwise any benefits will be paid to your estate.

Reversionary income streams can only be payable to a spouse or a child. The child must be either under 18 or under 25 and in full time studies. Where income stream payments are made to a child they must cease by age 18 if not in full time study, or by age 25 for a child in full time study.

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