Annuities are financial products designed to convert your retirement savings into a regular income during retirement. Understanding the key elements and risks of annuities is the first step to making informed choices about your retirement savings.
The three key elements of an annuity:
- Your initial income (first month pension)
- Your future income increases
- Your income security (the level of risk you are exposed to)
There are two main types of annuities - guaranteed annuities and living annuities. You can invest in one of them or both. Either way, the most important thing is to make an informed choice.
| Living Annuity | Guaranteed Annuity |
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How it works | - A living annuity is like a bank account. Your retirement savings are invested in an account and your savings grow according to the investment returns you earn.
- You receive your income (monthly pension) from this account, and this depletes your savings over time.
- The higher the income you choose, and the lower your investment returns, the greater the risk that your savings will not last throughout your retirement.
| - You use your retirement savings to purchase an annuity policy from a provider (an insurance company).
- The provider uses your retirement savings to pay you an income (monthly pension) according to the terms of your policy.
- Your income is guaranteed for life.
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Your initial income | - You choose your own initial income as a % of your savings.
- There are a minimum and maximum allowable income (this will vary between 2.5% and 17.5% of your total savings).
- Your fund may have negotiated further restrictions.
| - A provider will quote you an initial income based on your purchase amount and the optional features you choose.
- Different providers may quote different incomes.
- Quotes will change as market conditions change.
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Your future income increases | - You may review your income each year and decide what your income for the next year will be as a % of your savings.
- There are a minimum and maximum allowable income (this will vary between 2.5% and 17.5% of your total savings).
- Your fund may have negotiated further restrictions.
| Your future income is determined by the type of guaranteed annuity you purchase: - Inflation-linked annuity: Your future increases are linked to inflation rates that will vary from year to year.
- Fixed increase annuity: You decide on a fixed annual increase at the time you purchase the annuity and it can’t be changed thereafter.
- With profit annuity: Your future increases are based on the investment performance of the investment portfolio. There may be no increases, but your income wouldn’t decline.
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Managing your income in future | - You are responsible for managing your income.
- Each year you must review and decide:
- What will be your income for the next year?
- The investment portfolios you will use.
- Whether to use some or all of your capital to purchase a guaranteed annuity.
| - You do not have to manage your income - the provider takes care of everything.
- All the terms and conditions are set at the time that you purchase the policy.
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Key features and risks | Features: - You benefit in times of good investment performance.
- Your unused retirement savings can be passed on to your dependants after you pass away.
- You have the option to transfer to another provider or convert to a guaranteed annuity at any time.
Note: Trustees may negotiate a living annuity for your fund - in which case: - You pay low administration and investment fees.
- Your trustees determine the investment portfolios available to you.
Risks:- Your income is not guaranteed. If you draw too much income or your investment returns are poor, you could run out of money.
- You are responsible for the ongoing management of the investment.
- You can lose out in times of poor investment performance.
| Features: - Income is guaranteed for life and the provider has the obligation to pay you an income for the rest of your life.
- You may choose optional features such as a guaranteed term or spouse’s pension.
- The product provider takes care of the ongoing management of the investment.
Risks: - The payment terms and optional features are fixed at the start and cannot be changed later.
- Additional options come at a cost which may reduce your income.
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What happens if you die? | - Your unused retirement savings are passed on to your dependants and/or beneficiaries when you die.
| It depends on the features you choose when you purchase the policy: - If you chose a single life pension, the pension payments will stop at the time of your death.
- If you chose a spouses pension, your spouse will continue to receive the income you chose.
- If you chose a guaranteed term, your income will continue until the end of the term or be paid out as a lump sum to your estate.
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