Annuities

Annuities are a way of turning your retirement savings into a regular income. You pay a lump sum to an insurance company and in return, the insurance company will make regular - usually monthly - payments to you. These payments are a fixed amount. They will continue for a set number of years, or until you die, depending on the type of annuity.

Annuities aren't commonly used in New Zealand, and there are advantages and disadvantages.

Advantages

The main advantage is that an annuity provides a steady, regular income, making budgeting easier during your retirement. Buying an annuity also removes the need for you to invest and manage your retirement savings, which can become difficult if your physical or mental health deteriorates in later life.

If you buy an annuity that lasts until you die, you also get the security of knowing your money won't run out. The insurance company will keep paying even if you live much longer than expected. However, the size of the regular payout may be smaller if you buy a lifetime annuity, rather than one that lasts for a fixed number of years.

Disadvantages

It is important to note that depending on the type of annuity you buy, the regular payments may stop when you die. If you die early in retirement the insurance company may get to keep a substantial amount of your money. Some insurance companies try to reduce this risk by offering a guaranteed payout period.

That means, if you die early the annuity will continue to be paid to your estate. However, you pay a 'price' for this by getting a lower amount each year while you are alive. Whether you think that 'price' is worth paying depends on how you regard your financial obligation to any dependants or to the people you have chosen to leave your money to after you die.

The other disadvantages of annuities are:

• Inflation could be high, eroding the value of the fixed payout. However, for a lower annual annuity amount, you can buy an increasing annuity - say, 3% a year.
• You no longer have a large chunk of money for big purchases. If you spend all of your retirement savings on an annuity, you will reduce your flexibility to cope with unexpected expenses.
• You might pay more tax on the investment income component of the annuity. The life insurance company pays 33% tax, effectively on your behalf. You pay no tax on the annuity you receive but, had you invested the money yourself you might have paid less than 33% tax.

Only life insurance companies can sell annuities. Some annuities are designed for couples. Generally, when the first partner dies an amount (that could be less) is paid to the second partner.

Before you buy an annuity check it out carefully. There are only a small number of companies that offer annuities, so although they may be a good idea the non-competitive market results in relatively low rates of return and relatively high expenses. Talk to other retirees about their experiences and get some independent advice. Check out our checklist for financial advice.

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