Monthly Archives: September 2017

Life annuity retirement income

Risk of Living too Long negated through life annuity

Ensuring retirement income stream over remainder of one’s life is the key purpose of the superannuation system.  The benefits of taking out a life annuity are explained but, for the reasons given below, it is quite rational, that people in Australia decide not to purchase an income stream in the form of an annuity.

The provision of the Australian Government Age Pension provides the ultimate protection against longevity. This leads one to avoid the more costly approach, the purchase of a life annuity, to cover one’s risk of living too long and thus running out of retirement income.  A generally conservative investment strategy and margins deducted from returns detract from the efficiency of life annuities by reducing returns.

Conservative investment strategy

To provide a long-term income stream for life, requires the issuer of a life annuity to invest in assets that are highly likely to be around in many years’ time. These assets are therefore required to be secure and accordingly have a commensurately lower rate of return.

Margins to cover capital charges

The issuer of a life annuity is required to hold capital, to offer the protection against risks, insolvency and liquidity, and the providers of such capital require a return on their capital.  Margins are therefore taken out of the asset returns, to compensate the providers of capital, reducing the return available to the life annuity holder.

Margins to cater for improvements in life expectancy

The uncertainty of improvements in the life expectancy of the general population is a risk that is borne by the issuer of life annuities.  An additional margin therefore has to be allowed out of the returns on all assets to allow for this possibility.

The lower returns from the conservatively invested assets and the margins deducted from such returns results in lower income streams while the risk of the annuity provider failing remains with the owner of the annuity.

In early retirement, while well-being allows for a full lifestyle, the life annuity holder will under spend, and not have access to capital.  Conversely, in very old age when lifestyle needs are far lower the annuity income remains and access to the Age Pension is also available.  Thus the life annuity has come at a very real cost to the holder by having invested conservatively, carried all the margins to compensate the life annuities issuer for the risks.  The net result of funding retirement income through the use of a life annuity results an under spending in the early years of retirement and then when lifestyle needs reduce significantly, at very old age, a level of income remains that cannot used, other than to leave by way of bequest, which is not the purpose of superannuation.

Further reading:


How much superannuation is necessary

Superannuation is made up of:

  • the accumulated contributions made into the fund over a person’s working life, and probably
  • the value of life insurance in the event of premature death

The question you need to ask yourself is:

  • How can I make sure that my superannuation balance will be enough for me to live on for the rest of my life?
  • How do I work out how much insurance I need?

These questions are of vital importance to everyone.  Very few people consider them and solve them satisfactorily.

Household bills and budgeting

Budgeting for houshold expenses

If you are an employee, your superannuation contributions and therefore the ultimate accumulated balance is determined by how much you have earned over your lifetime.  This does not reflect what you need for your retirement.  Furthermore, in Australia the conversion of the accumulated superannuation lump sum into an income stream is not mandatory.

When it comes to the life insurance component, most people have no idea how much insurance is necessary to support their dependents.  As the superannuation industry generally provides everyone with a nominal amount of cover without any careful and original thought to determine an appropriate level of insurance many are left with the false comfort that their insurance needs have been properly considered. aims to offer some ideas for you to consider  the superannuation lump sum required and a life insurance amount appropriate for you.

In planning your financial future the risks that you have, particularly with the potential for long-life, is that you superannuation balance will not support your desired income for your remaining life.

Secure income streams that guarantee the fulfillment of the planner’s desire for the provision of living expenses and ongoing support for the family are also not without risk.

An income stream for life

An income from superannuation lump sum

The following simple story aims to explain the difference between a superannuation lump sum payout  or a lump sum payout from life insurance policy and a regular income.

Suppose you went to a building contractor and said, “I want you to build me a house.” “What kind of a house?” “Well,” you say, “a Colonial, brick house, with ten rooms, three baths, and a sun porch, slate roof, hardwood trim and floors, open plumbing, and hot-water heat.”

Sometime later he calls you on the telephone and says, “I’ll drive you out to look at your new house.” You motor out to a beautiful section of the city and stop in the midst of a group of handsome homes.

The contractor says: “Here’s your house, just what you ordered.” But you are puzzled. There isn’t any house opposite the place where you have parked the car. “Where is my house?” you ask. “Right here,” he answers, pointing at the block before which you have stopped. “But there isn’t any house there,” you exclaim, in amazement. “There is nothing on that lot but a heap of bricks, barrels of lime, lumber, kegs of nails, building hardware, slate shingles, plumbing supplies, and cans of paint.”

“Well, I call that a house,” says the builder. “A house!” you exclaim. “Why, that is only the material out of which a house may be built.” A superannuation lump sum is only the brick and mortar of the House of Protection.  And yet every day, all up and down this country, superannuation and related life-insurance policies, intended to furnish permanent support are settled in lump sum and people are saying to themselves with satisfaction, ”I have provided my family protection in event of my premature death.”

Adapted from: Lovelace, Griffin M., 1876-. The house of protection, 1921. New York and London, Harper & brothers.

Conversion of superannuation lump sum

The conversion of accumulated superannuation into an income stream is not mandatory.  However the benefits of converting superannuation or a life insurance settlement into an income stream are enormous.

Most people believe that their superannuation or life insurance will provide for them into retirement or their dependents in the event of their premature death. The accumulated balance in superannuation represents a portion of a person’s average lifetime earnings and most people don’t plan how much this will amount to.  Alternatively, how life insurance will support their dependents.  Superannuation contributions are made at a mandated level and some people may have a basic level of life insurance.  In order for these two things to provide for retirement or dependents, it’s important that they are invested to provide an income stream.

In these circumstances, dependents need to be protected. But how are they protected and indeed what is ”protection”? According to the dictionary, protection is that ‘which preserves or keeps from injury or harm’. What is the danger or harm from which superannuation and life insurance is intended to shield dependents?  It is the lack of food, shelter, clothing, medical care, education, and reasonable comforts, either for life or for a specified period.

Does superannuation and life insurance, as it is arranged in the average case, really protect the beneficiaries against the lack of the necessaries and reasonable comforts of life? Unfortunately, there is no doubt as to the answer to this question.  It is emphatically ”no.” The average person is not actually guaranteeing protection to the family, as thought.

Further Reading

Income from Superannuation lump sum

What is a life annuity contract?

The key feature of a life annuity contract is that it is payable for a person’s lifetime.  The basic requirements of a life annuity contract are set out in the description and purpose of an annuity that is payable for the lifetime of the owner. Below is an explanation of the parties to an annuity contract as well as the various options available to you to allow you to tailor your annuity contract.

Parties to an annuity contract

A life annuity contract is created when you pay a lump sum to a life annuity contract issuer and agree on the terms of payments to be returned to you at regular intervals over your lifetime. The issuer of life annuities is usually a Life Insurance Company. The purchaser of an annuity is the person who wishes to receive the regular payment. The person who receives the regular payments of an annuity is referred to as the annuitant. The annuitant might be two people in which case they are referred to as joint annuitants. There are occasions where the purchaser of an annuity and the annuitant are different persons.

There are two different kinds of annuities:

  • Guaranteed annunities
  • Equity linked annuities

Guaranteed annuities explained

Guaranteed annuities are the traditional annuities and the older of the two under which the promised benefits are 100 per cent guaranteed by the issuer. Under a guaranteed life annuity, the level of income promised to the annuitant is based on the long term prevailing market interest rate at the time the annuity is purchased. Under this kind of annuity, the regular annuity is payable for the lifetime of the annuitant or another person.

Equity linked annuities explained

An equity linked annuity offers no guarantee of what you will earn from your annuity because the underlying investments from which the annuity is paid by the insurer is invested in equities or unit trusts and the return on these is uncertain. Equity linked annuities offer no certainty of income or the term over which the regular payments are receivable. The annuitant carries the risk.

Options available for guaranteed annuities

The initial payment for the annuity determines how much will be paid out as an income stream. The age of the person receiving and the annuity and their life expectancy determines the level of income they will receive. An older person will receive a higher income because of a lower life expectancy.

With reference to guaranteed annuities, the individuals can decide which of the following is important to them.

  •  the period over which the annuity is payable
  •  frequency of the income payments, and
  •  whether the payments escalate or reduce.

An annuity can be payable for a person’s lifetime or may be limited to a certain period. If it’s limited to a certain period, the income stream will generally be higher.

When you purchase an annuity, you can choose to have regular payments made annually, bi-annually, quarterly or monthly. Annuities are generally paid in arrears and less frequent income payments will result in slightly better income levels.

At the start, you can choose whether the life annuity is to change in line with changes in the consumer price index. Furthermore, if you have chosen a joint annuitant, you may elect a reduced annuity to be paid to the surviving joint annuitant on your death. By electing a reduced income for the second annuitant, you will benefit from a higher income stream initially.

External information

MoneySmart definition and description of annuity