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Tax and Social Security Implications

Written by Carrie T. Ratzlaff    Tuesday, 20 December 2011

Not surprisingly, the tax and social security arrangements for annuities are not without their complexities. The simplest rules are those that apply when you are 60 and use your superannuation savings to buy an annuity to generate a retirement income stream. As with account-based pensions, annuity income for most Australians is likely to be tax free and should also enjoy the usual social security concessions on income that apply to account-based pensions. This relates to the fact that part of the income is not included when applying Centrelink's age pension income test. The amount excluded each year is the starting amount invested to provide the income stream, divided either by your life expectancy or number of years, if a fixed term has been chosen. As Louise Biti of Strategy Steps explains, things get a bit more complicated when you use non-superannuation savings to buy an annuity. To work how much of your annual annuity income is taxable, you first have to calculate what is known as the undeducted purchase price or UPP. This, in effect, is the amount you paid for the annuity. After this you need to divide the UPP by what is known as the "relevant number". For lifetime annuities this is your life expectancy at the time the annuity is purchased. If the annuity is for a fixed term, the relevant number will be the number of years it is payable. If the annuity has a residual capital value (that is, some capital is left at the end) then the tax-free amount of the annual annuity payments is equal to the UPP minus the residual capital value. This amount is then divided by the relevant number. For example, if a single male, aged 65, pays $100,000 for a 20-year annuity with a $50,000 residual capital value then the tax-free amount of income is $100,000 minus $50,000, all divided by 20, or $2500 a year. This is also the amount that is deducted from the annual income payment when applying the age pension income test. As for the assets test, the amount of the annuity that is counted in a particular year is calculated by multiplying the $2500 by the number of years that have elapsed and then deducting this from the purchase price. In the case of the above example this means that after five years $87,500 of the $100,000 spent to buy the annuity is included when applying the age pension assets test. A similar test is applied to annuities purchased with superannuation to determine the amount assessed as an asset.

Last Updated ( Tuesday, 20 December 2011 )