Complying superannuation income streams are either account-based or non-account based.
Since 1 January 2006, SMSFs are only allowed to commence an account-based income stream (read, Paying pensions for more on this). While SMSFs can’t commence a non-account based income stream directly, they can commence a non-account based income stream indirectly by purchasing it from an external life insurance company. These are commonly known as annuities.
With a non-account based income stream, such as a ‘term certain’ or ‘lifetime income stream’ (annuities), the product provider carries the investment risk and effectively guarantees the income payments.
This section covers term certain or lifetime income streams (annuities) that an SMSF can purchase from a life insurance company.
Term Certain Income Streams (Annuities)
Term certain income streams offer a ‘guaranteed’ income stream for a fixed number of years. The maximum term is the number of years until the member turns 100 years, although some life insurance companies may set a lower number of years. At the end of the term, the payment stops.
The income payments are fixed, although they can be indexed for inflation.
Once commenced, term certain income streams are inflexible products and access to capital is likely to be restricted. Some term certain income streams may provide for a residual capital value.
If the member dies before the term expires, income payments may continue for the balance of the term to a reversionary beneficiary, or the remaining income stream may be commuted to a lump sum and paid to a dependant or the estate.
Lifetime Income Streams (Annuities)
Lifetime income streams pay a ‘guaranteed’ income to the member for his or her life. If a reversionary beneficiary is nominated, upon the death of the member, the payment continues to the reversionary recipient (who must be a dependant under the tax laws) for the rest of his or her life.
If the reversionary dependant is a child, the income payments must be ‘commuted’ by the time the child reaches age 25, which means the income payments must stop and a lump sum may be taken.
The income payment under a lifetime income stream can be indexed for inflation.
Lifetime income streams provide security through a guaranteed income, and eliminate any longevity risk as the member can’t outlive their money, which could occur with a term certain income stream. However, they are inflexible products in that access to the capital is extremely limited.
Generally, products with a residual capital value are not offered. Some life insurance companies may offer products with a ‘guarantee period’ which provide insurance against a large loss of capital due to the member’s early death. This is an optional feature, which of course results in a lower income payments.
If the member dies during the guarantee period and hasn’t nominated a reversionary beneficiary, the remaining guaranteed income payment will be converted into a lump sum. If the member has nominated a reversionary beneficiary, the guarantee applies where both member and reversionary beneficiary die before the end of the guarantee period.