Some mechanics behind annuities

Annuities come in various shapes, forms and sizes. People refer to an annuity in different contexts and variations all the time. In Australia the type of annuities on offer have changed a lot in my almost 10 years in the industry. I like to think of an annuity as giving a lump sum money to an annuity provider in exchange for a regular income for life in retirement. There are also new products called lifetime income streams which to me are just another form of annuity but probably not technically actually an annuity.

Some annuities have a fixed term, such that you invest in them for say a 5 year period, almost like a term deposit. Others can be market-linked so the returns and income aren’t guaranteed, rather they can fluctuate with what happens in the type of investment that has been selected.

A popular one or what I see as a “traditional” annuity, is you give a lump sum of money as mentioned prior, to the annuity provider, then the annuity provider will set the terms agreed upon by you at the start. This can include the annuity provider paying you income for life in exchange for the lump sum of money. This income could potentially be lower if the annuity provider lets you have some level of access to capital during your expected lifetime, or it can be a higher level of income, for example if you choose not to have any capital access.

Annuities can almost be considered as sort of insurance that your money won’t run out. You essentially give the annuity provider a lump of money in exchange they will pay you for life in some circumstances, now the annuity provider has actuaries that have done the statistics and they are aware that a certain amount of people won’t live out their statistical life expectancy’s and a certain amount will live beyond. One of the mechanisms of making a profit is having more people pass away sooner rather than later put simply. Investors though have piece of mind, just like paying for insurance that if something unforeseen happens (i.e. you live to 100 years old) that you will continue to have a regular income.

In Australia it is important to consider the Centrelink impact of annuities and how they are treated, sometimes it can benefit you from an asset or income perspective to hold an annuity but there is certain criteria that needs to be met for Centrelink to apply this preferential treatment.