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.
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.
| 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.
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. |
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 |
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.