Annuities: trading a lump sum for a steady income

An annuity is a contract that swaps a lump sum for a promised regular income. Moneysmart's annuities guidance puts it plainly: it's a financial product you can buy from a life insurance company or friendly society, using your super or other savings, and you pay a lump sum of money in return for a guaranteed amount of income, for a set amount of time.

The first choice is how long the payments last: a fixed number of years, or the rest of your life. How much income you get is set by what you paid in, how long the payments run, and the other product features you choose. Notice what an annuity isn't — it isn't an investment account with a balance you watch go up and down. There's no balance at all once you've bought it; there's a provider, a contract, and a payment that arrives on schedule.

That's the whole pitch. With a conventional annuity, the payment amounts aren't affected by market performance — markets can crash and the income keeps coming, which Moneysmart notes might suit someone who doesn't want to bear investment risk. The lifetime version goes one further: payments from a lifetime annuity last as long as you do, so it's income you cannot outlive.

Annuities come off an order form with a handful of choices, and each one reshapes the income. Term first: fixed-term or lifetime. Annuities that pay for the rest of your life are a type of lifetime income stream — a product built to pay for as long as you live, however long that turns out to be. Fixed-term versions pay for the number of years you nominate, then stop.

Then, how the payment behaves. With a conventional annuity the payment is set when you buy, based on how much you put in, how long it's invested for and how often you want to be paid — and you choose whether the income stays level, increases each year by a fixed percentage, or is indexed to inflation, meaning it rises with the cost of living. Some products instead offer investment-linked payments, where the income goes up or down with a chosen investment option: the duration is guaranteed, but the amount is not. Most annuities let you pick monthly, quarterly, half-yearly or yearly payments — agreed at purchase, and rarely changeable afterwards.

Finally, whose name is on it and what happens when you die. Ordinary savings can buy a joint annuity: if one partner dies, the survivor keeps ownership and access, and a joint annuity allows income splitting between partners for tax purposes. Super money is different — an annuity bought with super can only be in the name of the person who owns that super. On death, payments usually stop unless you chose otherwise up front: a reversionary beneficiary, a nominated person (usually a partner or dependant) who keeps receiving the income for the rest of their life, usually at a reduced level — or a guaranteed period, a minimum payment window in which your beneficiary gets the remaining payments, unreduced, as a lump sum or income stream. Features and conditions differ between products, so Moneysmart's advice is to compare before you buy.

Start with the capital, because it's the biggest concession: when you buy an annuity you give up the chance to invest or spend that lump sum yourself. Once the cooling-off period — the short window after purchase in which you can still back out — has passed, you can't change the payment terms. And in most cases you cannot withdraw your money as a lump sum at all; some products allow withdrawals in limited circumstances, but Moneysmart warns that significant penalties may apply.

Next, the upside you forgo. Your payments are locked to the deal you struck on the day you signed — so if markets or interest rates do well afterwards, a conventional annuity doesn't share in it. Moneysmart notes the income from an annuity may be lower than the returns from investing the lump sum yourself, and that this is more likely when you buy a conventional annuity during a period of low interest rates. The timing of the purchase quietly sets the terms for decades.

The quietest risk is inflation. A level payment that feels comfortable at the start buys less every year, and an annuity can run for a very long time. Moneysmart's warning is direct: your payments might not keep up with inflation unless you chose an annuity whose payments sufficiently increase over time. That's why the indexing choice on the order form isn't a detail — it decides what the income actually buys at the far end of the contract.

Moneysmart is explicit that retirement income isn't all-or-nothing: you may benefit from a mix of options rather than putting everything into one product. Seen that way, an annuity is rarely the whole plan — it's the certainty leg. One common way to think about the mix is to point guaranteed income at the spending that continues no matter what markets do, and leave the rest of the savings somewhere flexible, rather than locking the lot away.

The flexible leg is usually an account-based pension — a regular income stream bought with super money when you retire, where the money stays invested in options you choose. It's the annuity's mirror image: no guaranteed payment, but you can vary the income (above a government-set minimum each year), take ad hoc lump sums, or close the account entirely. Where the annuity's income is fixed and untouchable, the account-based pension's is adjustable and accessible — which is exactly why the two are often discussed together. Retirement income maps the full menu.

The third leg is the Age Pension, and this is where annuities get genuinely technical. An annuity forms part of the income and assets tests that determine Age Pension eligibility, and Moneysmart notes lifetime annuities can increase your access to the Age Pension because of more favourable treatment under those tests — but how that plays out depends on the product and your circumstances, so read the current treatment on Moneysmart's annuities page rather than any summary of it. This is exactly the kind of question Moneysmart suggests taking to a Services Australia Financial Information Service officer, your super fund, or a licensed financial adviser before you buy.