Guaranteed Retirement Income Plans: Pros, Cons & Types

Guaranteed Retirement Income

Knowing you have a guaranteed income throughout retirement can be comforting, but there’s got to be a catch, right?

This article explains how guaranteed retirement income works, the types of guaranteed retirement income streams and the pros and cons.

What is Guaranteed Retirement Income?

Guaranteed retirement income is a type of retirement income that is achieved by paying a lump sum capital amount in exchange for an agreed income amount, paid at regular intervals, for a predetermined time frame.

The provider of a guaranteed retirement income stream bears all the risk of being able to provide that level of income for the agreed period of time.

This differs from an account-based retirement income stream, which provides flexible retirement income, yet is not guaranteed to provide income of a specific amount for a specific timeframe.

While the overall concept of each guaranteed retirement income stream is largely the same, there are various types with differing features.

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Types of Guaranteed Retirement Income Plans

Types of guaranteed retirement income plans include:

  1. Guaranteed Fixed Term Annuities
  2. Guaranteed Lifetime Annuities
  3. Defined Benefit Income Streams

Each of these retirement income plans has a guaranteed nature, yet the specifics make them unique.

1. Guaranteed Fixed Term Annuity

A fixed term guaranteed annuity is purchased with a lump sum from a superannuation or life insurance provider with either superannuation or non-superannuation monies.

In exchange for a lump sum amount, a guaranteed fixed term annuity provider will guarantee to provide you with a certain level of income for a predetermined time frame.

The factors determining the amount of income provided by a term annuity include:

  • Purchase Price – The lump sum amount used to purchase the annuity.
  • Interest Rate – The interest rate offered by the product provider.
  • Time Frame – How many years you would like the guaranteed income for.
  • Indexation – Whether or not the payment increases each year with CPI or partial CPI.
  • Residual Capital Value (RCV) – The level of capital (if any) you would like returned at the end of the term.

A guaranteed fixed term annuity has the greatest level of certainty, because all of the quantities are known at the commencement of the retirement income plan.

2. Guaranteed Lifetime Annuity

A guaranteed lifetime annuity is also purchased with a lump sum from a superannuation or life insurance provider, but the timeframe differs from that of a fixed term annuity.

A lifetime annuity guarantees to provide an income stream for the remainder of your life, regardless of how long you live.

Generally, if you were to die prematurely – in the initial years of purchasing the annuity – part or all of the purchase price is paid to your estate.

The factors determining the amount of income provided by a lifetime annuity include:

  • Purchase Price – The lump sum amount used to purchase the annuity.
  • Interest Rate – The interest rate offered by the product provider.
  • Life Expectancy – The number of years away you are from your statistical life expectancy.
  • Indexation – Whether or not the payment increases each year with CPI or partial CPI.
  • Death/Withdrawal Benefits – Whether you choose to retain or remove death/withdrawal benefits in exchange for higher payments.
  • Reversionary Status – Whether the income stream will continue on to a beneficiary in the event of death (this option will reduce your payments).

Oversimplified, when it comes to lifetime annuities, if you live longer than your statistical life expectancy you win; if you don’t, you may lose out, financially.

3. Defined Benefit Income Stream

A defined benefit income stream may arise as part of your superannuation retirement plan when working for government or semi-government organisations.

This could be instead of or in addition to an ordinary superannuation accumulation account.

The way a defined benefit superannuation plan works is that once you retire, you will often have the option of taking the benefit as a lump sum, an income stream, or a combination of the two.

If you opt for a defined benefit income stream, the amount received is essentially calculated in the same way as a lifetime annuity works.

Some defined benefit pensions are 2/3rds reversionary to a spouse in the event you were to pass away.

Lump sum withdrawals are generally not available once a defined benefit pension has commenced.

Benefits of Guaranteed Retirement Income Streams

Some of the benefits associated with guaranteed retirement income streams include:

  • Certainty – the guaranteed nature of the income provides a level of comfort that you won’t need to worry about when or where your next payment will come from.
  • Predictable – you know exactly how much retirement income you will receive, when you will receive payments and for how long.
  • Low-Risk – the risk of providing the income for the agreed time frame rests with the provider as they have an obligation to you. You are not reliant on market returns.

While there are a number of benefits associated with guaranteed retirement income streams, it is important to also be mindful of the risks, disadvantages and shortcomings.

Risks of Guaranteed Retirement Income Streams

The risks and disadvantages of guaranteed retirement income streams include:

  • Lower Returns – The effective return on your capital for a guaranteed annuity is generally conservative and lower than what could be achieved through a more diversified portfolio.
  • No Access to Capital – Guaranteed annuities and income streams are not designed to give you the ability to access lump sums. Some products do allow it, but it’s not intended for this.
  • Premature Death – If you have no reversionary beneficiary, no (or low) RCV and no death benefit option, then a premature death could result in a significant financial disadvantage.
  • Low Flexibility – Once a guaranteed income stream commences, you usually have little control of the level of income, the payment frequency and the effective interest rate achieved.

If you are comfortable with these downsides of guaranteed income streams, then one might be for you.

Alternatives to Guaranteed Retirement Income Streams

There are a number of types of retirement income streams.

The main alternative to a guaranteed retirement income stream is an account-based pension, which is almost the opposite in all respects.

An account based pension is commenced using a lump sum amount (just like an annuity), but the level of income is flexible to your needs and can be altered at any time, subject to a minimum amount. The balance is invested into assets chosen by you and lump sum withdrawals are permitted.

Unlike a guaranteed income stream or annuity, an account based pension does not guarantee to provide an income for a predetermined time frame.

The longevity of an account based income is determined by the level of income withdrawn and the investment earnings within the account.

The recipient/owner of an account-based income stream bears the risk of how long the retirement income will last.

Frequently Asked Questions

Listed below are some frequently asked questions around guaranteed retirement income streams and annuities. All figures have been obtained from Challenger’s Lifetime Annuity quoting software in January 2024.

How much does a $300,000 annuity pay per month?

The amount a $300,000 lifetime annuity pays per month depends on a number of factors, including but not limited to your age, sex and the interest rate on offer.

As an example, a 65 male would receive approximately $1,300 per month with full-CPI indexation and a 65 female would receive $1,250 per month (due to having a longer life expectancy).

How much does a $500,000 annuity pay per month?

The amount a $500,000 lifetime annuity pays per month depends on a number of factors, including but not limited to your age, sex and the interest rate on offer.

As an example, a 65 male would receive approximately $2,195 per month with full-CPI indexation and a 65 female would receive 2,070 per month (due to having a longer life expectancy).

How much does a $1 million annuity pay per month?

The amount a $1 million lifetime annuity pays per month depends on a number of factors, including but not limited to your age, sex and the interest rate on offer.

As an example, a 65 male would receive approximately $4,390 per month with full-CPI indexation and a 65 female would receive $4,150 per month (due to having a longer life expectancy).

How much does a $2 million annuity pay per month?

The amount a $2 million lifetime annuity pays per month depends on a number of factors, including but not limited to your age, sex and the interest rate on offer.

As an example, a 65 male would receive approximately $8,780 per month with full-CPI indexation and a 65 female would receive $8,285 per month (due to having a longer life expectancy).

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