How does a variable annuity work when you retire?

Retirement income

Turn your super or other savings into a guaranteed income when you retire

3 minutes

An annuity, also known as a lifetime or fixed-term pension, gives you a guaranteed income for a number of years. Or the rest of your life.

An annuity is less flexible than an account-based pension, but you can be sure about your future income.

How an annuity works

You can use your super or savings to buy an annuity from a super fund or life insurance company.

When you buy an annuity, you choose whether you want the payments to last for:

• a fixed number of years
• your life expectancy, or
• the rest of your life

Preservation age

If you are using super money to buy an annuity, you must have reached preservation age (between 55 and 60).

You must also meet a condition of release, such as permanently retiring.

Joint or individual annuity

You can use savings to buy an annuity in joint names. This allows income splitting for tax purposes. If you or your partner dies, the survivor has ownership and access to the funds.

If you use a super lump sum to buy an annuity, it can only be in the name of the person who 'owns' the super.

Income from an annuity

You decide the payment amount you receive when you buy the annuity. Your annuity income can increase each year by a fixed percentage, or indexed with inflation.

You can choose to be paid monthly, quarterly, half-yearly or yearly.

An annuity bought with super money must pay you a certain percentage of the balance, based on your age. The Australian Taxation Office website has more information about minimum annual payments.

Your annuity if you die

When you buy an annuity you can either nominate a reversionary beneficiary or choose a guaranteed period option.

• Reversionary beneficiary — Your nominated beneficiary (usually your partner or a dependant) will get your income payments for the rest of their life. This is usually at a reduced level, for example, 60% of your income stream.
• Guaranteed period — A minimum payment period is set when you buy the annuity. If you die, your beneficiary will get your payments, either as a lump sum or income stream. The income payments will not reduce.

How an annuity affects the Age Pension

An annuity forms part of the income and assets tests to determine your eligibility for the Age Pension.

A Services Australia Financial Information Service (FIS) officer can help you work out how an annuity will affect your Age Pension entitlement.

The difference between an annuity and an account-based pension

Share market performance doesn't affect annuity returns. This makes an annuity one of the more stable retiree investment options.

With an account-based pension, your money is invested in a range of investments, including shares, property and bonds. This gives potential for better growth and investment performance. Share market performance does affect returns, making an account-based pension riskier than an annuity.

Pros and cons of an annuity

Consider the pros and cons to decide if an annuity is right for you. Get financial advice from your super fund or a licensed financial adviser if you need more information.

Pros

• A regular guaranteed income regardless of how share markets perform.
• Suitable for someone who doesn't want to bear investment risk.
• An annuity bought with super money is tax-free from age 60.
• An indexed annuity protects you from the rising cost of living.
• Payments from a lifetime annuity will last as long as you do.
• If you nominate a reversionary beneficiary, a spouse or dependent will receive some income if you die.
• If you choose a fixed-term guarantee period, your estate gets some money if you die during that time.

Cons

• You cannot choose how your money is invested.
• Income payments will be low if the annuity starts in a period with low interest rates.
• You can't change the amount you receive in income once payments start.
• You lock your money away until the term of the annuity ends.
• You cannot withdraw your money as a lump sum.

Using a mix of retirement income options

You don't have to take an all or nothing approach to your retirement income. You may benefit from a mix of options, such as an annuity, account-based pension or lump sum.

Consider your personal needs and circumstances before making a decision. Your super fund, a licensed financial adviser or a Financial Information Service (FIS) officer can help.

A variable annuity is a type of annuity that includes subaccounts invested in the stock market. No matter how its investments perform, a variable annuity can guarantee you’ll receive a series of payouts that start when you retire and last throughout your life, provided you annuitize (begin taking payments) before the contract loses all its value.

Your variable annuity’s investment performance may affect the size of the distributions you receive. Higher gains will likely translate into higher payouts. Lower gains—or losses—will likely result in smaller payouts.

A variable annuity offers several key features: income in retirement, potential tax-deferred investment growth based on market performance, and—depending on the contract—potential to pass money on to your heirs.

• Income in retirement. Like other annuities, a variable annuity can provide ongoing income payments during retirement.

• Investment growth potential. Variable annuities let you choose from a variety of investment options within your contract. Some people prefer this option over a fixed annuity, which grows in value based on a predetermined, fixed interest rate.

• Tax-deferred growth. As with a 401(k) or a traditional IRA, a variable annuity’s earnings are tax-deferred. That means they aren’t taxed while you’re contributing to the annuity, which may result in higher growth. Later, when you take income payments out, that money is subject to income tax.

• Potential to pass money on to your heirs. Most variable annuities also offer a standard death benefit. That's money paid to your beneficiaries if you pass away before annuity payouts begin. Optional death benefits may require a policy rider that comes with an additional cost.

Read more: How variable annuities can help support your retirement goals.

Immediate and deferred variable annuities differ based on how quickly they begin providing income.

An immediate variable annuity starts its payouts shortly after you put money in. You fund it with a single premium. Soon (within a year—and it may be within 30 days), it starts paying you income. That leaves little time for earnings to accumulate. Your recurring income payment amounts can change over time because they're tied to the performance of the annuity’s investment subaccounts.

Read: What is an immediate annuity & how does it work?

A deferred variable annuity requires a waiting period between the time you start putting money in and the time you receive its income stream. You can fund a deferred variable annuity with a single premium or a series of payments. Your income withdrawals begin when you retire (or at some other future date, as stated in your contract). Between the time you start making payments and the time you begin taking withdrawals, earnings can build up. Increasing your contract’s value can increase the income payments it provides. Many people use deferred variable annuities as part of their overall retirement planning strategy.

Read: What is a deferred annuity & how does it work?

Variable annuities differ from fixed annuities in the way they grow (or decrease) in value. A variable annuity’s value rises or falls based on the market performance of its investments. A fixed annuity is guaranteed to grow at a predetermined interest rate.

When considering one or the other, some people opt for the riskier variable annuity because it may achieve a higher rate of return. However, if the market trends downward, a variable annuity could earn less than a fixed annuity—or even lose all of its value.

A fixed annuity’s guaranteed interest rate may only promise a modest return. But it protects against the possibility of loss and offers the advantage of knowing ahead of time exactly how much the annuity's value will grow.

Say you’re 15 years from retirement. You have some money saved up and invested through a 401(k) or an IRA. Perhaps you have one of each. But you’re not sure they’ll provide enough money to support you through your retirement years.

If you have a lump sum of money available—or can fit a new recurring premium payment into your budget—you could put that money into a variable annuity. That would ensure you’d receive additional income starting on a designated date (your 65th birthday, for example) and lasting the rest of your life.

Knowing your annuity’s investment performance would likely affect how much money the annuity would pay out each year, you could choose how much risk to take on. Investing more aggressively could heighten your risk for loss—but also have potential for higher returns. Investing more conservatively might limit your potential loss but generate lower earnings. Often, it makes sense to base such decisions on how your other retirement savings vehicles are invested. That can help you build a well-balanced portfolio.

That depends on many factors, including your age, your financial goals, your retirement plans, the resources you have available, the amount of risk you wish to take on, and how long you expect to live.

Have you maxed out your allowed Roth IRA or 401(k) contributions? Would you like to put more money away to help support yourself (and, perhaps, your spouse) in retirement? If so, a variable annuity may be worth considering. By choosing how to invest its subaccounts, you can make sure it fits well within your overall financial strategy. And knowing you have a guaranteed income stream coming might make you feel more confident about your retirement plan.

Want to learn more about if a variable annuity is right for you? Connect with a Thrivent financial advisor.