Create Your Own Personal Pension With Annuities
Annuities have been getting a lot of attention in the press lately. But they are still dismissed by people in – or close to – retirement.
Maybe they would be viewed a bit more favourably if they were given a different label – like Guaranteed Income for Life.
Once you leave your job you no longer need a retirement savings plan – you need a retirement income plan.
Boomers aged 55 and older are facing a retirement that could last 20 or 30 years, or even longer. The danger or living a long life is that as expenses increase you might just run out of money. For those relying on secure government or company defined benefit pensions, life span uncertainty may not matter that much.
….the majority of working Canadians – about 68% of the workforce – are currently pensionless.”Moshe Milevsky, “Pensionize your Nest Egg”
For others whose main sources of retirement income are not guaranteed for life, it matters a lot. These retirees can convert their retirement nest eggs into their own pension by buying annuities.
Related: Protecting Your Retirement Nest Egg
What exactly are annuities?
An annuity is an exchange of your lump-sum of cash to an insurance company for a guaranteed income for as long as you live, regardless of what the financial markets are doing.
The payments can continue for the life of the purchaser (or joint lives of the purchaser and spouse). Some annuities have guarantee periods if the annuitant dies before a minimum number of years.
They come with different features, but the more features you choose, the lower the payments.
Annuities can be bought with registered funds (RRSPs, locked-in RRSPs, defined contribution pension plans) as well as non-registered money. If you buy with registered funds, payments must start the year after you turn 71 and are fully taxable. An annuity bought with non-registered funds is only partially taxed because you’re receiving a partial return of your original investment.
The longer you wait to purchase that annuity, the greater your payments. You might want to stagger your annuity purchases over several years to help increase payouts.
Rates available will fluctuate based on factors such as the interest rates at the time of purchase, actuarial factors predicting how long someone might live, and how much the company wants to attract a particular kind of annuity sale at the time you’re wanting to buy. This site will give you an idea of the rates available in today’s market.
Commissions on annuities are paid once (at the time of purchase), with no ongoing trailers or commissions paid to an advisor
The cash flow you’re entitled to is actually made of your own money, interest, and other people’s money. Essentially, when people die the remaining participants benefit. That’s how you get rates well above bond and GIC rates payable today.
Once you purchase an annuity you can’t change your mind and you can’t cash out – it’s a done deal.
Annuities are insured by Assuris, which covers 85% of the annuity payment up to $2,000 per month. If a life insurance company fails, the assets are transferred to a solvent company.
Annuities have been unpopular lately and lack of knowledge about them definitely plays a role. They are perceived to have high fees (not necessarily true) and our current low interest rates result in lower annuity payments. Few are willing to give up control and hand over hard-earned assets to the annuity issuer. There’s especially the fear of losing it all to the insurance company if you should get hit by a runaway bus right after signing your documents.
How annuities can help in retirement
Statistics show quite clearly that Canadians are living longer. While longevity sounds like a great benefit, living a long life can create financial challenges.
Nothing protects you from longevity risk like a guaranteed lifetime income. Single-life annuities give you payments like those from defined benefit pension plans, CPP and OAS.
None of us know how long we will live, but statistics can give us an idea of our lifespan.
A 65-year-old Canadian male has a 25% chance of living to age 94, and a 65-year-old female has a 25% chance of living to 96. This table demonstrates why a certain level of guaranteed income might be a good idea.
Take Tom, a relatively healthy 70-year old male who uses $250,000 to purchase an annuity from SunLife. He would receive $17,082.24 a year. If he reached his median life expectancy of 84 years, he would have collected $239,151.36 in annuity payments. Call this more or less the break even point.
What happens if he lives to age 90? or 95? He’ll be $100,000 to $200,000 ahead. Remember, you’ll want to plan for living beyond life expectancy.
If he should die tragically a couple of years after he bought the annuity, well it wouldn’t really matter to him and, with the 10-year guarantee period, his beneficiaries would receive the payments until the contract expires.
You can choose to have your annuity benefit paid to you monthly, quarterly or annually, but most retirees elect a monthly payout which can help you budget for monthly expenditures.
You don’t have to invest your entire retirement savings into an annuity. You might at least cover your basic living needs for life and leave the remaining funds in your investment portfolio for liquidity and growth.
Having the guaranteed income from an annuity can also keep you from under-spending in retirement as a precaution against outliving savings. It would make it possible to withdraw more from your portfolio and spend a bit more freely in the early years.
Related: Generating Cash Flow in Retirement
Who should buy an annuity?
Retirees might consider incorporating an annuity into part of their retirement income strategy for these reasons:
- Annuities may be an investment solution for conservative retirees. Wade Pfau, a professor of retirement income at the American College says, “Consider an annuity as part of your overall fixed-income allocation.”
- Someone without a defined benefit pension plan may benefit from guaranteed monthly income for life if they’re worried about outliving their savings. Note that longevity and outliving savings is a particular concern for women with their longer life expectancies.
- Do-it-yourself investors may also be candidates. As people age, they can become less able to make complex financial decisions, and this is a real risk for DIY investors in their 70s and beyond. Moving RRSP/RRIF savings into an annuity means less money to manage, and possibly less retirement income risk in the later years of retirement.
- Leaving a legacy to your children is not a priority.
New – The Advanced Life Deferred Annuity
The latest Federal budget proposed an interesting investment option by introducing the Advanced Life Deferred Annuity (ALDA).
Starting in 2020, anyone with a Registered Retirement Savings Plan (RRSP), Registered Retirement Income Fund (RRIF), or similar plans including Defined Contribution Pension Plans will be permitted to purchase this annuity with up to 25% of their registered accounts.
With an ALDA, planholders would be able to defer payments until the end of the year they turn 85. There is a lifetime maximum of $150,000 that would be indexed to inflation and rounded to the nearest $10,000.
One benefit of putting money into an ALDA is longer tax deferral because the minimum required RRIF withdrawal is reduced up to the age of 85. This would be an advantage to seniors who are still working or would otherwise have a high tax rate in their 70’s, and those who receive GIS payments. It might also reduce OAS clawbacks for high-income retirees.
It would also help to separate a portion of retirement savings for later retirement years, which can often be more expensive due to higher health care costs.
The bottom line
Outliving one’s money is the most frequently cited financial fear among retirees. Sure, we have mortality tables and family history to help guide us, but statistically speaking, half the population will outlive their median life expectancy.
If you knew how long you were going to live you could budget for it and withdraw an appropriate amount each year from your assets. But longevity is uncertain, and extreme longevity, however unlikely, could have large negative financial consequences.
Consider that investors hoping to live on RRSP/RRIF interest, dividends and capital gains have no guarantee their money will last as long as they will. With still-low interest rates and the possibility of stock-market losses and rising inflation, the prospect of outliving your money is a real concern.
Annuities could be a viable option for some retirees. It’s a product that many retirees should consider as part of a diversified income strategy.
If you value flexibility and control, they may not be enticing enough. That’s okay. They are not for everyone.
But the more options Canadian retirees have available to them the better it will be.