Investing for Your Retirement 

This section provides a general overview of income streams. For more detailed information on income streams read Retirement Income Streams on the FaHCSIA website.

Introduction

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

Trying to match the investment in income streams to your income needs can require some considerable thought. In practice, our retirement income needs will vary throughout retirement years.

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.

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

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

Retirement income streams are investments which allow you to obtain regular income and capital payments, and thereby provide you with a basis for managing ongoing income and spending patterns.

Some retirement income streams are not very flexible and you should consider the advantages and disadvantages of each type of income stream carefully. After becoming more familiar with them you may decide that other options best suit your needs.

Types of income streams

There are two main types of retirement income streams – pensions and annuities. A pension is the name given to income streams which are payable from superannuation funds, whereas an annuity is the name given to income streams which are generally payable from life insurance companies. There are many similarities between these two types of income streams. The key point to focus on first is what type of features do you want from your income stream?

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

Account based income streams

The ‘account based’ variety is the most flexible type of income stream. When you invest in an account based income stream, you have an investment account within the relevant fund. Your investment account balance will increase as investment earnings are added to your account and decrease as you draw down regular income payments. For as long as the income stream lasts, you will have an account balance. The most common type of account based income stream has been referred to as an allocated income stream. A more recent type is a term allocated pension.

Non account based income streams

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

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Who provides retirement income streams?

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

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

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

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

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

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

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

Industry funds—a number of industry funds provide pension benefits to members. Those that pay pension benefits generally restrict their activities to allocated pensions.

These funds first became popular when superannuation became part of various industry awards. Management of the fund includes employer and employee (often union) trustees. Many of the large industry funds now have (limited) public offer status and are available to a wide range of workers.

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

Self managed funds—these funds (which are also often referred to as DIY funds) make up a significant part of the Australian superannuation scene. Self Managed funds will have 4 or less members and more commonly one or two members only. While most are used by people in the pre-retirement phase of life, an increasing number are being used to provide retirement income streams.

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

Which one?

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

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

If this suits your needs then investing in more than one income stream may be the best option. There is no limit on the number of income streams you may invest in. In fact, you may choose to invest in more than one income stream simply to spread your risk.

What are the risks?

As with any investment, retirement income streams involve some degree of risk. Everyone views risks differently, however with income streams there are three main dimensions to risk:

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

Certainty—means how predictable the amount of the payments are from the income stream.

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

However, within the range of income streams available there are ways in which you can reduce risks to a level that you are comfortable with. What you need to do is to match the most appropriate income stream (or streams) and their features to your own specific circumstances.

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Comparison of different types of income stream products

Account based and non account based income streams have a range of features that can vary considerably. However, there are some general features common to each which can be considered when trying to determine which income stream may best meet your circumstances. The advantages and disadvantages of these are summarised below.

Advantages and disadvantages of account based income streams

Advantages

1. You have significant flexibility in the income you draw from year to year.
2. You generally have access to your money at all times.
3. You receive a regular income payment.
4. You usually have a range of investment options to choose from.
5. Your family, beneficiaries, or estate will receive the investment account balance on your death.

Disadvantages

1. You do not have a guarantee that the regular income payments will continue for your lifetime or any fixed term.
2. You may be subject to unfavourable fluctuations in investment markets.
3. You need to continue to be involved in the decision making process each year.
4. You can only use ‘superannuation money’ as the purchase price.

Advantages and disadvantages of non account based income streams

Advantages

1. They provide a guaranteed level of income for a fixed term or for your lifetime and possibly that of a spouse also.
2. 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.
3. Once you have made your initial choices these products are very simple – you receive a regular income for the term or the rest of your life.
4. For lifetime products, you may ‘gain’ significantly if you live a long time.

Disadvantages

1. From an income viewpoint they are inflexible, as you do not get to choose a different income level at any time.
2. You cannot generally access any of the money you invest at any time.
3. 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.
4. For lifetime products, you may ‘lose’ some capital in the event of premature death.

 The following table provides a summary of the different types of income stream products and shows how their features vary.

Notes:

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 per cent assets tested.

What are the tax rules?

The tax rules for your retirement income stream will depend your age and the type of fund that is paying you the income stream. However, because there are so many variations that are available, you need to discuss these issues with your financial adviser or accountant.

More detailed information on tax and income streams is available in the publication Retirement Income Streams at www.facsia.gov.au and from the Australian Taxation Office at www.ato.gov.au or on 13 28 61.

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 can draw the whole amount out and not pay any tax on the amount. And because the amount is tax free you don’t even have to include it in your tax return.

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.

From 20 September 2007, all income streams, except defined benefit income streams, are counted for the assets test.

If you need more information about social security rules, read Retirement Income Streams at www.facsia.gov.au or you could seek further information from a Centrelink Financial Information Service Officer.

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