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.
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... |
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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%. |
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.
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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... |
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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. |
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.
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:
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