Planning for retirement is one of the most important financial decisions you’ll make, especially if you are between the ages of 40 and 70. With various options available, it’s crucial to understand the pros and cons of each to ensure your retirement income meets your needs.
This article will explore three popular choices for Australians: lifetime annuities, account-based pensions, and term deposits. We’ll break down the advantages and disadvantages of each option to help you make an informed decision.
1. Lifetime Annuities
What are Lifetime Annuities?
A lifetime annuity is a financial product offered by insurance companies that provides a guaranteed
income stream for life in exchange for an initial lump sum payment. Your income depends on factors such as age, gender, and the amount invested.
Advantages
Guaranteed Income for Life: A significant advantage of lifetime annuities is that they offer a secure
income for as long as you live, helping protect you against the risk of outliving your savings.
Protection Against Market Volatility: Unlike account-based pensions, the income from annuities isn’t
affected by market downturns, providing peace of mind during economic fluctuations.
Tax Benefits: Lifetime annuities can be tax-effective, especially for older Australians, as part of the
income may be tax-free, depending on the structure of the annuity.
Flexibility with Options: You can choose inflation protection, which means your income can increase
annually to keep pace with the cost of living.
Disadvantages
Lack of Access to Capital: You generally cannot access your capital once you’ve invested in a lifetime annuity. This inflexibility can be a disadvantage if you need a lump sum for emergencies or
significant expenses.
Lower Initial Income: Compared to other investment options, the initial income from a lifetime
annuity can be lower because it is structured to last your entire life.
Impact of Inflation: If you don’t choose inflation protection, the purchasing power of your annuity
income may decrease over time due to rising living costs.
2. Account-Based Pensions
What is an Account-Based Pension?
An account-based pension allows you to draw a regular income from your superannuation savings
once you retire. The income amount can be adjusted within specified minimum and maximum
withdrawal limits set by the government.
Advantages
Flexible Income Withdrawals: You can control how much income you receive each year, making it a
flexible option that allows adjustments based on your needs.
Access to Capital: You retain access to your remaining superannuation balance, giving you the
freedom to make lump sum withdrawals if required.
Potential for Growth: Funds in an account-based pension can continue to grow as they remain
invested, potentially increasing your income over time.
Disadvantages
Market Risk: Since your funds remain invested, your pension income is subject to market
fluctuations, which can impact the value of your investments and income stability.
Longevity Risk: There’s a risk of outliving your savings if your withdrawals and market losses deplete
your super balance faster than expected.
Administration and Management Fees: Account-based pensions may incur ongoing fees, which can
erode your overall returns.
3. Term Deposits
What are Term Deposits?
A term deposit is a fixed investment with a bank or financial institution where your money is locked
away for a specified period at a fixed interest rate.
Advantages
Certainty of Returns: Term deposits offer a fixed interest rate, providing certainty of returns over the
investment period.
Low Risk: They are a low-risk investment option as they are not subject to market fluctuations and
are protected by the Australian Government Guarantee up to $250,000 per account holder, per
financial institution.
Simplicity: Term deposits are easy to understand, making them an attractive option for those who
prefer straightforward investments without the complexities of managing superannuation funds or
annuities.
Disadvantages
Limited Growth Potential: Interest rates on term deposits are often lower than other investment
options, and your returns may not keep up with inflation, eroding your purchasing power over time.
Inflexible: Your money is locked in for the term’s duration, and early withdrawals can attract
penalties, limiting access to your funds if needed.
No Ongoing Income: Unlike annuities or pensions, term deposits do not provide a regular income
stream; interest is usually paid at the end of the term or periodically.
Comparing Your Options: Which Is Right for You?
When choosing between lifetime annuities, account-based pensions, and term deposits, consider the following:
- Income Security vs. Flexibility: If guaranteed income for life is a priority, a lifetime annuity is a strong choice. However, if flexibility and access to capital are more important, an account-based pension might suit you better.
- Risk Appetite: For those averse to market risk, term deposits and annuities offer more certainty, while account-based pensions carry more risk but also more potential for growth.
- Inflation Protection: Lifetime annuities with inflation protection options can safeguard your income’s purchasing power, whereas term deposits and fixed annuities may lag behind inflation.
- Access to Funds: Account-based pensions and term deposits provide better access to your capital unlike lifetime annuities, where access is usually restricted.
Conclusion
Choosing the right retirement income option involves balancing security, flexibility, and risk. Lifetime
annuities provide a guaranteed income for life but lack access to capital. Account-based pensions
offer flexibility but expose you to market risk. Term deposits are simple and low-risk but may not
provide the income or growth needed to keep up with inflation. Ultimately, the best option depends
on your financial situation, risk tolerance, and retirement goals. Consulting a financial adviser can
help tailor a retirement strategy that suits your needs, ensuring a comfortable and secure
retirement.
Should you require further information about annuities or account-based pensions, please feel free
to contact Peter Quinn by submitting an enquiry or calling us on +61 2 9580 9166 to book an
obligation-free appointment.
The information in this document does not take into account your personal objectives, financial
situation or needs and so you should consider its appropriateness having regard to these factors
before acting on it. It is important that your personal circumstances are taken into account before
making any financial decision and it is recommended that you seek assistance from your financial
adviser.