You've saved hard all your working life to build up a sizeable superannuation nest egg and now you want to turn your retirement savings into regular income you can live on. But choosing between the different types of retirement income products has left you even more confused. This SelectingSuper retirement income stream guide should help.
By Alex Dunnin

KEY POINTS
When you retire you should consult Centrelink and your financial adviser. If investing in an income stream you should also consider obtaining independent legal advice. Pensions are paid from a super fund while annuities are paid from a life insurance company. The main types of income stream products are “allocated” income streams, “lifetime” income streams, “life expectancy” income streams, “fixed term” income streams, and “market linked” income streams. The value of your income stream payment is determined by the capital value you invested, less the amount of money being paid, plus any investment income.

You've worked hard for years and saved up a sizeable retirement nest egg and now you want to retire. This simple decision however puts you right into the thick of decisions about how you should structure your retirement income streams to maximise your Centrelink entitlements, minimise your tax liabilities and ensure that your money lasts as long as possible. 

The first thing you should do is contact Centrelink and arrange to speak to one of their Financial Information Services Officers. These specialists however are not financial advisers and they will not give you investment and product advice, but they will explain to you what your Centrelink entitlements are, how the various assets and income tests may work, and how you may wish to structure things to maximise your entitlements regarding the age pension, health care benefits and other assorted benefits.

The second thing you should do is talk to your super fund and ask them to explain how they can help you. For example, many super funds now offer a range of products designed specifically for people who have retired and you need to understand how they work and which ones may be suitable for you. 

The third thing you should do is probably the most important. You should arrange a meeting with your financial adviser because choosing the right retirement product can be a very complex decision. Indeed, it may even be a good idea to road test several financial advisers. While most quality super funds now have their own financial advisers, and you may have already spoken to one at your own fund, you should probably meet with an independent adviser just to get a second opinion.

Income Streams and Their Key Features

		Allocated		Lifetime		Life expectancy		Fixed term		Market linked
Flexibility of income		Yes, but some limits		Generally no		Generally no		Generally no		No, but depends on level of investment income
Payments are guaranteed		Not usually		Yes		Yes, for agreed term		Yes, for agreed term		Not usually
Can access capital for special purposes		Generally yes		Generally no		Generally no		Generally no, subject to agreement about residual		Generally no
Investment choices		Generally yes		No		No		No		Generally yes
Good for estate planning		Yes		No, but loss of capital in some cases		Yes		Yes		Yes
Source of investment		From super only		For pensions, from super		For pensions, from super only		For pensions, from super only		From super only

Source: Adapted from the Department of Families, Community Services and Indigenous Affairs

Retirees have different investment needs

One of the reasons why its so important to get good advice when you retire is because your savings and investment needs are very different to when you were still working. This is because when you were working you were only concerned with what is known as the “accumulation” phase of superannuation, meaning how to pick the right investment types to help your super grow as fast as it can without taking too much risk. 

When you retire however, the game suddenly gets more complicated. Do you take the money as a lump sum, as a regular weekly, monthly, quarterly or yearly payment (referred to as an “income stream”), and how do you do this in such a way where you maximise your Centrelink entitlements, maximising your regular total income, minimising your tax problems, and making sure you are not going to be withdrawing so much money from your retirement savings that your money runs out too quickly.
These differences between your pre-retirement and post-retirement savings needs also explain why you will quickly be confronted with very different types of investment products to the ones you used before you retired. For example, you will soon have to decide between “allocated” income streams, “lifetime” income streams, “life expectancy” income streams, “fixed term” income streams, and “market linked” income streams. 

But the first decision you will have to make is between how much of your superannuation savings you want as a lump sum that you can spend now, and how much you want to set aside to fund an income stream, also known as a regular payment. And this is where it starts to get complicated because while the two main types of income stream products are pensions and annuities, there are however quite a lot of ways these can be structured. 

The key thing to understand however is that while superannuation is now tax free after age 60, income stream products are still a very important way to make sure your money lasts as long as you do. This means that while they may not be about avoiding tax anymore they are still about your quality of life and whether you will have enough money to live on.

How your income stream account works

The two main types of income stream products are pensions and annuities. It is a pension when you receive the income stream payment from a super fund, and it is an annuity when you receive it from a life insurance company - even if it's only a technical distinction, knowing these terms is still helpful. 

The differences are important because with a pension you are probably already a member of a super fund and so they already have your superannuation savings and you just want to choose the most effective way to receive regular payments. But annuities are a little different because you have to enter into a special contract with a life insurance company for them to pay you regular amounts in return for you handing over your lump sum, often several hundred thousand dollars. 

Regardless of whether you are taking a regular pension or receiving annuity payments, the issues are now that you have to decide how regularly you wish to “access” your income stream, what level of “income” or regular payments you wish to receive, and what level of “investment earnings” you would like to receive. 

The value of your income stream account at any one time therefore reflects the amount of money you have invested in the product, called the capital value of the income stream, less the amount of money paid in regular payments plus any interest that is credited to your account as investment returns. 

This last aspect is quite important to understand because for income stream types where your provider guarantees your regular payments, the trade-off is the money will be very conservatively invested and so even if investments markets boom you still won't get any extra money. However, for income stream types that are much more flexible, like ones where you can choose your own investments, while the income stream provider doesn't guarantee your regular payments or even that your money won't run out, the upside is that if you make good investment returns then you get the extra money as either increased payments or your money will last longer.

Allocated income streams

The most flexible type of income stream products are allocated pensions and allocated annuities. This is because they usually give you a full range of choices about how often you want to receive regular payments, whether would like to withdraw lump sums from time to time for special purposes (like going on a holiday, repairing your house or buying a car), and they let you choose your own investments. 

Because these allocated income streams are so flexible, the downside is that it is possible you will use up all your money before the end of your life, which will force you to have to rely solely on the age pension. 

But because of this flexibility these are the most popular of all the income stream products accounting for nearly 80 per cent of income stream products sold in Australia.

Lifetime income streams

To protect yourself against your money ever running out you can however choose a lifetime income stream. The trade-off for this guaranty that your money will never run out is that the size of the regular payments you will receive will be lower than in a regular allocated income stream. This is because your income stream provider has to make sure there is enough money to pay you each week, month, year, or whatever, and the longer they expect you to live the more careful they have to be. This also means there is no investment choice with these products. 

Since the income stream provider has to ensure your money lasts as long as possible, you generally will not be allowed to withdraw any extra money for those special purposes, no matter how important. In this way, lifetime income stream products are the least flexible type of all income stream products.

Life expectancy income streams

If you think the size of the regular payments you will receive from a lifetime income stream will be too low, another option is to instead choose a lifetime expectancy income stream where your payments will continue up until when you are expected to die. 

For example, if you are age 65 and you elect to have a lifetime expectancy income stream, the income stream provider may nominate that they expect you to live another 18 years, meaning they will make regular payments to you until you are age 83 and then the payments will stop. 

Like with lifetime income stream products, you will generally not be allowed to withdraw any extra money from your savings and there is no investment choice.

Fixed term income streams

With fixed term income streams, you are specifically agreeing with the income stream provider how long you wish to receive regular payments. In this way, with these income streams you know exactly what to expect and for how long. And even if you die before the term is completed your estate or your preferred beneficiary will usually be allowed to keep on receiving the regular payment. 

However, like with the types of income stream products we've talked about so far, you will generally not be allowed withdraw any cash for a special purpose. But you can nominate that at the end of the fixed term that you may like to receive, say, 10 per cent of the money you initially invested. This is called the Residual Capital Value. The money will be invested and the amount of the regular payments will be structured so that this amount is left at the end of the term. 

Indeed, these fixed term income streams are almost like car leases many people may already be familiar with. Because fixed term income streams offer all these guaranties, if course there is no investment choice.

Market linked income streams

Market linked income streams are a new type of income stream product where not only do you receive regular and locked in payments, but the value of your investment capital can increase because these products let you choose your own investments. The implication however is that if you choose high performing investment options you have the potential to either significantly boost the size of your regular payments or extend the period for which your regular payments will last before the money runs out. 

These income stream types - sometimes also called term allocated pensions or growth pensions - are similar to a morphed version of fixed term and life expectancy income streams because when you purchase them you have to nominate a fixed period of time for which you wish to receive regular payments, which is usually set at your life expectancy. The growth aspect of the income stream of course refers to how the capital value of your investment can grow in relation to investment returns, though it can also go backwards if markets under-perform. 

However, it is very important to understand that while these market linked income streams seem to offer the best of all world's they do come with a catch - that there are no guarantees about what level of income you may receive in regular payments. This is because the level of investment returns might change the size of the capital and if it deteriorates because of poor returns the income stream provider may have to lower the size of your regular payments to ensure your money lasts as long as the fixed term for which you have agreed to receive regular payments.

Fees

The types of fees you are likely to pay your income stream provider will of course vary depending upon who the provider is and how many and what types of features it has. 

Similarly to regular super funds, the main types of fees are contribution fees, ongoing management fees, member fees, and investment fees. But because your income stream product is quite different to a regular “accumulation phase” super fund in that you now receive regular income, there will often be a regular administration fee associated with your provider having to make these payments. 

Most importantly, because an investment in an income stream product usually means you have saved up a large amount of money, most quality income stream providers should waive any contribution fee, or at the very least only charge a very low contribution fee like say 1 per cent.

According to Rainmaker's latest 2006 allocated income stream survey, the average TER should be around 1 to 1.5 per cent each year. This fee level will of course vary considerably depending upon the capital value of your income stream. 

Other factors likely to increase your fees are the more investment choices that are available, especially in investment linked income streams, and how often you wish to receive regular payments. For example, you should expect to pay higher fees if you wish to receive 12 monthly payments rather than just one annual payment.

What happens when you die

The unfortunate reality about retirement income streams is they involve estate planning and this is why it is often a very good idea to get independent legal advice, as well as financial advice, before agreeing to invest in your income stream. 

The three main issues concerning income stream products if you die before the capital runs out are therefore: their reversionary status, the value of the residual lump sum, and the flexibility of the outstanding payment. 

Reversionary status refers to how allocated and investment linked income streams can be set up so that upon your death the payments continue to be paid to your nominated beneficiary, while the residual lump sum refers to how the outstanding capital value will be paid in cash to your nominated beneficiary.

The flexibility of the outstanding payment refers to how some income stream products may allow a preferred beneficiary to nominate a choice of whether they wish to either continue receiving the regular payments or whether they wish to receive the outstanding amount as cash.

Want More Information?

For more detailed information about retirement income stream products, contact your nearest Centrelink or Department of Families, Community Services and Indigenous Affairs office. You can visit their websites at www.centrelink.gov.au or www.facsia.gov.au.

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