The earning rate is fixed at the outset, and this applies for the length of the annuity, regardless of share market movements or interest rate fluctuations.
Capital can be returned at the end of the agreed term or gradually during the term of the annuity as part of the regular payments.
Unlike many other products, annuities carry no product fees. That is, they do not charge management, administration, performance, entry or exit fees.
Annuities have a number of features that can be tailored to suit different needs. The main features are as follows (click on the term to read the explanation):
'Term' refers to the length of an annuity policy, as selected by the individual investor. Fixed term annuities are generally available for terms of between one and 50 years. The term of a lifetime annuity is the rest of the investor's life - no matter how long they may live.
The earning rate (or rate) refers to the interest paid by a fixed term annuity. It is agreed upfront and applies throughout the term of the annuity. For example, an investor taking out a $100,000 three-year annuity, offering a rate of 3.75 p.a. with regular annual payments and 100% return of capital, would receive $3,750 each year.
When purchasing an annuity, an investor elects the amount they wish to be regularly paid. Payments can generally be made monthly, quarterly, half-yearly or annually.
The amount paid can be fixed at the outset for the term of the investment, or can be indexed by a set percentage or indexed to inflation. With lifetime annuities, payments can be either fixed at the outset or indexed to inflation.
Indexing to inflation may be particularly useful with respect to long-term annuities because it provides protection against increases in the cost of living.
The ability of an annuity provider to continue fixed, regular payments does not rely on the underlying investments but is guaranteed by the provider, which is a prudentially regulated life company holding capital expressly for the purpose of managing investment volatility.
When purchasing a term annuity, an investor elects the proportion of capital they'd like returned to them at the end of the investment term. Any capital left at the end of an annuity term is known as 'residual capital value', or RCV. It can be 100% of the capital invested, 0% of the capital, or somewhere in between.
As shown in the illustration below, in the case of a 100% RCV annuity (also known as RCV100), income payments are made up entirely of interest earned on the investment. The initial investment amount is preserved and paid back to the investor when the policy ends.
At the other end of the spectrum, regular payments for a 0% RCV annuity (also known as RCV0) will each include interest earned on the investment and a portion of the original capital invested. There is no capital left at the end of the term of the annuity.
The RCV can generally be set at any level between 0 and 100. If an RCV of 40 is set, then 60% of the initial capital is paid out through regular payments and 40% is repaid to the investor at the end of the term.
What are the fees of the annuity?
Unlike most products, an annuity has no separate management fees. We pay for the costs of running the annuity and derive income from the return on our investment portfolio, minus the earnings rate paid to you. Note though that you may have agreed to pay fees to your financial adviser for helping to manage your money.
Adviser service fees
You may agree to pay a fee to your financial adviser for the services they provide. You can instruct us to pay fees (if any) from the annuity as outlined in the relevant product disclosure statement.
Which features are best for you?
If you decide to invest in an annuity, your personal circumstances and cash flow requirements will determine how to construct your annuity investment. We, therefore, recommend that you consult your financial adviser and read the relevant product disclosure statement before acting.
Note that if you've bought your annuity with superannuation money you'll be subject to minimum annual withdrawal amounts which are set by the Government.