“Overlooked” annuities can play a key part in delivering retirement income

While most people are relieved that interest rates are starting to head back down, there’s another group – savers – who are less pleased.

So writes Rob Carrick of The Globe and Mail.

“Declining interest rates are great for borrowers, but they take an axe to returns for people who want to avoid putting their money at risk,” he notes, observing that guaranteed income certificate (GIC) rates have fallen to about five per cent these days from a high of six per cent a year ago.

But interest rates are still higher than they have been for decades, and that’s good for those thinking about investing in an annuity, he notes.

“Annuities have also been affected by lower rates, but you could still get a lifetime yield of five per cent as of recently,” he writes.

Hold up. A yield on an annuity? An annuity is where you hand the provider a lump sum of money, and they guarantee you a monthly lifetime payment. It’s not like a bond or GIC that matures at a key date – it’s paid for life.

Carrick explains.

“What’s lifetime (annuity) yield? It’s a way of looking at annuity returns that was used recently by Clay Gillespie of RGF Integrated Wealth Management to make a point,” he writes. “A life annuity is an insurance contract where you exchange a lump sum of money for a guaranteed stream of lifetime income that is usually paid monthly. Basically, you’re buying your own pension,” he continues.

“It’s hard to say what the actual return is from an annuity because you don’t know how long you’ll live. What Mr. Gillespie did was calculate returns based on life expectancy,” Carrick explains.

In the article, a 65-year-old male converting $100,000 to an annuity would receive $582 a month, and has a life expectancy of 21 years. That’s a yield of 5.3 per cent, the article explains.

For a woman of the same age and same $100,000 annuity, the income is $544 a month for 24 years, a yield of 5.5 per cent.

These calculations assume the people will live an average lifespan. If they live longer than 21 or 24 years respectively, they still receive a monthly payment. If they live less than the average lifespan, their payments stop when they pass away.

“This brings us to a legitimate reason why annuities remain a fringe retirement product. If you die in the years shortly after buying one, you end up having sacrificed a chunk of your savings to buy a short-term flow of income,” Carrick writes.

However, there are even some remedies for those who die younger than expected, the article continues. Some annuities have guarantee periods, say five years. “If you die during (the guarantee period), your beneficiary or your estate will get” the balance of the money left over, the article explains. Other types of annuities provide for some or all of the payment to continue to your surviving spouse.

On the plus side, an annuity means you will never run out of money during your lifetime, the article observes. The article suggests putting some of your money – enough to cover everyday costs – into an annuity and continuing to invest the rest.

Did you know that the Saskatchewan Pension Plan offers its retiring members the option of converting some or all of their account balance to an annuity? Options include annuities with a guarantee period, and annuities that continue to a surviving spouse. The SPP Pension Guide provides complete details on available annuity options.

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Annuities prevent you from outliving your investments: Jonathan Kestle CFP, CLU, H.B.Com

The higher interest rates of the mid-2020s are making people revisit an old retirement planning friend, the annuity.

An annuity is a financial product that you can buy which then pays you a specified amount each month for the rest of your life. While you no longer have control over the money you used to pay for the annuity, your monthly income payments from it are guaranteed to last your lifetime.

Save with SPP reached out to Jonathan Kestle of Ian C. Moyer Insurance Agency to find out more about annuities.

Q. We’ve not seen anyone comment on how choosing an annuity takes away the headache of having to make withdrawals from a registered retirement income fund (RRIF) or similar vehicle (a minimum amount that must come out, taxation, perhaps increased income and further taxation, etc.) Does having an annuity for some or all of one’s retirement income simplify their taxes?

A. An annuity will not necessarily simplify taxes unless it is a “non-registered” annuity, meaning the funds used to purchase the annuity are regular taxable savings and not from registered savings (Registered Retirement Savings Plans (RRSPs), a Locked-In Retirement Account (LIRA), etc.)

What an annuity does simplify, is the task of making a savings account last. Annuities eliminate the risk of outliving your investment and pay a pretty good payout rate in comparison to what would be prudent with a normal investment account.

Q. Similarly, when you choose an annuity you can pick one that can provide a spouse with a pension, or beneficiaries with a lump sum amount. If you have a lump sum, isn’t it possible that you’ll spend it all before you die and leave little or nothing to beneficiaries?

A. Not really, an annuity typically makes it harder to leave funds to beneficiaries. The guarantee periods are often limited to 10 or 15 years, at which point no money will pay to a beneficiary upon the death of the owner.

I would look at it this way… if you aim for a retirement income of $60,000, you could use an annuity to supplement your social benefits (such as CPP and OAS) to reach that amount. This way, you secure a steady income and preserve other investments, which can then be left to your beneficiaries.

Q. Interest rates have been persistently higher – are we seeing more annuities being chosen?

A. Yes. Now is a great time to consider an annuity. I checked today, and payout rates are up about 19% from 2021.

Q. Any other observations on the topic?

A. The payout ratio of an annuity is often overlooked. The “payout ratio” of an annuity is simply the amount of annual income received divided by the lump sum used to purchase the annuity. The concept is that those who unfortunately pass away early have their contributions support those who live longer. This mechanism is known as “mortality credits.”

Mortality credits are a unique feature of annuities. Essentially, the contributions from those who pass away earlier than expected are pooled and used to provide higher payouts to those who live longer. Because of this, annuities can safely sustain a higher withdrawal rate than a traditional investment portfolio. Achieving the same withdrawal rate from a traditional savings account would be too risky for many investors. This system allows annuities to offer more stable and predictable income throughout retirement, providing peace of mind for retirees.

We thank Jonathan Kestle for taking the time to answer our questions. Here’s a link to an earlier interview SPP did with him on annuities.

The Saskatchewan Pension Plan offers its retiring members a variety of annuity options. There’s the Life Only Annuity, which pays you and you alone a monthly income for life. There’s also the Refund Life Annuity, which can provide a lump sum benefit for your beneficiaries, and the Joint and Last Survivor Annuity, where your surviving spouse can continue to receive annuity payments after your death. Full details can be found here: retirement_guide.pdf.

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Darren Mitchell’s Be the Bank chronicles the author’s efforts to find a way for the average Jane or Joe to “control and compound” their wealth, in the way that banks and wealthy Canadians do.

The book’s story starts back in 2008, when Mitchell was a financial advisor. When the markets crashed, he was on an Alaskan fishing trip, trying to keep track of the carnage via cell phone. “It was sickening,” he writes. “There was nothing I could do… that’s when I realized that everything I knew about money was wrong.”

He wanted to find out why financial institutions and the wealthy got through market downturns fine, while those of us in the middle class coped with losses. He found that “the actions the wealthy took with their assets were the exact opposite of what the middle class did.”

Conventional investing in such things as registered retirement savings plans, registered education savings plans and tax free savings account are, the author suggests, very limited, with little control for the investor.

“Banks and Wall Street are in control. You roll the dice. You hope it all works out when you reach the top.” But, he writes, you need to face “retirement risks” such as taxes, inflation, “the possibility of long-term care,” volatile markets and fluctuating interest rates. “And,” he writes, there is also “the most significant risk of all: longevity.”

He looks at the conventional wisdom of withdrawal rates from investments that are based on 50 per cent stocks and 50 per cent bonds. He calls decumulation rates “the Monte Carlo process,” since you are taking money out of a fund without being able to predict how the fund will perform in the future. It’s a guess.

If you withdraw four per cent per year, Mitchell writes, you have a 57 per cent chance of outliving your money. If you withdraw three per cent, you still have a 24 per cent chance, he explains. “Is that how you want to live the rest of your life – in fear that you’ll run out of money, and with the real possibility that it’s exactly what will happen,” he asks.

After a look at the pros and cons of conventional investing, we come to the meat of the book. In Chapter 7, Mitchell says there is a solution that has been out there “for over one hundred years” that allows you to overcome most investment and decumulation risks – “a specially designed, dividend-paying, high-cash-value life insurance contract with a mutual company or participating whole life fund.”

Such products do come with “some death benefit” but “our focus is the cash value,” he explains. “Fewer than one per cent of life insurance policies sold in Canada are designed this way,” he adds.

Such products pay out steady dividends, he writes, with charts backing him up. Thanks to government regulations, such products charge very low management fees, usually lower than 0.18 per cent.

The longer you live, the more you get out of the product, so there is actually a longevity gain, Mitchell writes. Your growth, which after a few years “should be between 3.5 per cent and 5.5 per cent per month,” is tax -free and exempt from most conventional barriers to wealth accumulation, Mitchell explains. You can also borrow against your holdings to make a purchase, and since you are effectively the bank, you can decide when or if to pay the money back.

Mitchell’s book takes a look at annuities as a way to avoid market volatility.

“Think of an annuity like a government worker’s pension plan. They have a lifetime pension coming in every month until the day they die – guaranteed,” he says. And as well, he notes, an annuity addresses “the biggest retirement risk we will ever face… longevity. No matter how long you live, you will get paid,” he explains.

This book covers a lot of ground and it is hard to do justice to it in a short book review. But if you are looking for information on a different way to grow your personal wealth, via an insurance industry product, it’s worth having a look.

Annuities are becoming a better buy these days, since higher interest rates actually work in your favour, and give you more annuity income for the same purchasing dollar. Did you know that the Saskatchewan Pension Plan offers a variety of different annuity options for its retiring members? Check out SPP today for more details.

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U.S. study suggests annuity holders “feel more on track” in retirement

A new U.S. study has found that Americans who have annuities feel more “on track” and have a more positive outlook on retirement than those who don’t have annuities in their portfolios.

The study, conducted by Athene, a “leading provider of savings products,” was reported on in a recent article posted on Yahoo! Finance.

The study found that 75 per cent of those with annuities felt “on track” for retirement, versus a figure of 26 per cent for those without them, the report notes. The Athene study also found that 55 per cent of Americans worry they will run out of money in retirement, the article states.

An annuity (available to Saskatchewan Pension Plan members as a retirement option) is a financial product. In return for converting some or all of your savings into an annuity, you will receive a monthly lifetime pension for the rest of your life. And the higher rate of interest we’re experiencing is actually good news for those considering an annuity, since the higher the rate at the time of purchase, the larger your monthly annuity payment will be.

The study, which found that soon-to-be retired Americans worry about such things as inflation and market volatility, also found that not all respondents fully understand annuities. Twenty three per cent said they did not know what an annuity was, the article reports. However, 71 per cent said they would prefer to get regular monthly payments from their retirement savings versus “a lump sum,” which was preferred by just 29 per cent of respondents.

As well, only 22 per cent were aware that annuities “offer protection in down markets,” since once an annuity is selected, your monthly payment remains the same regardless of any market downturns, the article adds.

Getting a professional’s input is also seen as an important factor for those choosing an annuity, the article notes.

“In addition to ownership, working with a financial professional can also bring greater awareness of what an annuity is. Thirty-six per cent of adults who have never worked with a financial professional say they do not know what an annuity is, compared to the eight per cent of adults currently working with a financial professional who stated the same,” the article states.

“As market volatility and inflation continue to rise, it’s crucial for financial professionals and retirement savers alike to debunk the myths and truly understand the benefits and functionality of annuities,” states Adam Politzer, Senior Vice President of Product Actuary at Athene, in the article.

Those of us who have workplace pensions tend to either have a defined benefit plan, where you get a lifetime monthly payment based on a formula that looks at your earnings and years of employment, or some sort of capital accumulation plan where you save during your working years and then convert the savings to income on retirement.

The payout from a defined benefit plan is basically the same as annuity – retirees get a monthly payment for as long as they live, and there are options for survivors, including a lifetime pension based on some or all of the member’s pension.

In our own case, for example, we both plan to choose lifetime annuities from SPP, with 100 per cent of the payment going to whoever is the last standing. This is the same option we both chose for our workplace pensions, and as the article says, annuities feel more like getting a paycheque than getting one big payment a year might be. It also means we will have less “lump sum” money to manage overall – we think running the investments might feel more difficult once we are in our 80s and hopefully beyond.

With SPP, you can choose from a variety of annuities to convert some or all of your savings into monthly income when you retire. It’s pretty unique for any voluntary savings plan to offer an annuity option right within the plan – just another reason why so many Canadians are looking to SPP to play a part in their retirement savings program.

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Recently, Save with SPP got an opportunity to speak with long-time pension expert Dr. John Por, whose 40-year career in pensions includes consulting work with large U.S. and Canadian pension boards and offering expertise on pension risk policy. He has also researched the tricky “decumulation” stage in which savings are turned into retirement income.

Our far-ranging interview covered decumulation, spending in retirement, frugality, advice on saving for retirement, and annuities.

Decumulation

Dr. Por says common mistakes with decumulation – the stage where retirement savings are used to provide retirement income – can include problematic asset allocation, lack of appropriate goal setting, high investment costs and, often, setting a withdrawal rate that’s too high or taking out too much money early in retirement.

So is there a correct withdrawal rate?

“At one point in time, maybe 20-25 years ago, four per cent was said to be the right withdrawal rate,” he explains.

Decumulation “depends on future interest rates, the stock markets, inflation, life expectancy and income needs,” says Dr. Por. A “correct” rate “is therefore unknowable.”

“It depends on the reigning circumstances, both personal and market,” he explains. “Who could have predicted, even five years ago, the current existing zero or the negative real rate of bond returns?”

“The problem is, though we desperately want to find a magic formula, how can you do this – we don’t know how it will be (in the future); no one knows.”

Noting the volatility in the stock markets in just the last couple of years, he notes that “even a Nobel Prize winner professed not knowing where the markets will go in the next 10 years, or how to invest your money after retirement.”

“This, of course, has not kept the retirement or investment industry from providing copious, and often prudent, advice, it simply means that looking for a, or the, magic bullet, or the infallible sage, will not be successful,” he adds.

Spending in retirement

While decumulation carries a lot of unknowns, much more is known about how much retirees actually need, Dr. Por says.

He says research by noted pension actuary Malcolm Hamilton shows that people need far less “replacement income” in retirement than the 75 per cent figure bandied about by the industry. 

Hamilton has for many years said the research suggests not everyone needs to save “heavily” for retirement, because of the existence of government income programs for retirees and lower costs once you are retired. (Here’s a link to a Globe and Mail interview with Malcolm Hamilton.)

Dr. Por agrees, calling an overall 75 per cent rule “misguided.”

“While this may be true for low-income people, they are supported by the above-mentioned government programs, so for them the 75 per cent is not a stretch, people at higher income levels are not likely to need 75 per cent of their earned income to pursue an age-appropriate lifestyle,” he says.

“One of the most important steps to understanding (retirement spending) is… knowing how much money you need to survive,” Dr. Por explains.

Rather than going through “painful” pre-retirement budget forecasting, he recommends a simpler approach.

“How much do you save in a month? If the answer is zero, your retirement budget will be what you spend now, minus what you won’t have to pay in retirement.” This can include things like your mortgage, tax savings when you earn less, childcare and education expenses, Canada Pension Plan and Employment Insurance, and so on. 

It’s a common-sense issue, he says. Individuals must decide “how much is necessary (spending) versus how much you would like to have.”

This knowledge is crucial for retirees, who have extremely limited options in dealing with income shortfalls, he explains. 

Working Canadians needing more money could “work harder – get a job that pays better, spend less, save more, take more investment risks, etc.… but when you are retired, you don’t have the same tools,” he explains.

 “Lifestyle becomes the main tool, you can cut back on your lifestyle (to save money), which is difficult,” he says. “Another tool still at your disposal is taking on more investment risk in retirement, but, if you’re not successful, it would easily lead to a further diminished lifestyle,” Dr. Por adds.

Frugality 

At 74, Dr. Por says he is “still engaged” and “living frugally.”

In this context, he defines frugality as bringing your lifestyle and realistic earning capability (and not your hoped-for future earnings) into a healthy balance. 

Living frugally is a key way to make your money last longer, and also that when in financial trouble, the cutback would be smaller thus less painful. Big expenses in the early years of retirement should be avoided, he says, because you may need your retirement savings for decades. “

While at age 65 it is hard to envisage how long you may live” he explains, “you may easily live beyond age 90.”

For example, he adds, if you are married, “the probability that either you or your spouse will live to age 93 is about 50 per cent. You can live for a very, very long time.” 

Working after retirement is a way to support your retirement spending and to keep your mind active, he says.

“Some people still work part-time after they stop working full time. You don’t realize how important your work is … not that many people spend their time well in retirement,” he says.

“Apart from the income work provides, it also structures your day, can add meaning to your existence after retirement (admittedly not everybody needs it), and equally important, it helps you maintain your links with the outside world and friends,” he says. His observation is that most people (especially men) form the majority of their extra-family relationships through work, and once they retired such contacts tend to fade away over time,” he says.

Dr. Por recommends that everyone consider living frugally at any age; he sees it as a great lifetime habit to get into.

Saving for retirement

While some people suggest you should save for retirement from early in life until the end of your career, Dr. Por says that view isn’t usually realistic.

“You can’t save in your 30s and 40s – you are paying for your kids’ education, your mortgage. So, save what you can, if you can, but (know) you may not be able to,” he advises. “No heroism is called for, as you also have to live a reasonable life.”

The optimum time to save “is in your 50s, and then, you can save 20 to 40 per cent,” he says. By then, “your children will be out in the world, your mortgage is paid… you can save.”

For savers, equities add the most value, but of course, it depends on the environment you happen to fall into. Bonds don’t provide as much income and growth, Dr. Por explains.

Pay close attention to investment fees, he advises. “With exchange-traded funds (ETFs), you can control costs – the management expense ratios are low.” However, financial advisers may not suggest this investment because they can make higher commissions on other products, Dr. Por says.

“Even a fee of one percent can, over 30 years, reduce your available assets significantly,” he says.

What you want to avoid is being forced to sell securities when the market is down, thus Dr. Por likes the concept of having a cash reserve to tide you through periods of market decline. 

“If you take on extra risk… by putting more money into equities, you should also have a cash reserve fund worth three to five years of spending,” he says. If equities perform well, you may wish to extend such cash reserves to cover longer periods. Overall, Dr. Por says, a chief problem with retirement saving is that most people “look at it as an investment issue,” and become focused on today’s investment risks, interest rates, equity return rates, and so on. Instead, you should be thinking about the income your investments will generate when you stop working. 

What’s going on today with investment risks and other factors “is not relevant 30 to 50 years out,” when you will be drawing income from your investments, he advises. Your focus should be on that long term, and not on volatility or return rates in a given year, Dr. Por says.

Annuities

Dr. Por talked about the “annuity paradox”. While financial experts like annuities, most people refuse to follow such advice. Most people shy away from the idea of taking a large lump sum of money – say $1.5 million – and turning it into an annuity that pays $60,000 a year. He noted that when he mentioned the concept to his wife (a highly educated professional, an MD), she refused the idea saying that “… if we die soon for whatever reason the children will get nothing.”

Also, retired people want to have cash available for future expenses, and, not always unreasonably, are afraid of inflation, and the potential extinction of the financial institution, which issued the annuity. 

But, he added, “annuities later in life is a good idea”. When you are getting too old to run your money – say by your late 70s or 80s – that’s the time to consider an annuity, he says. The older you are when you convert to an annuity, the cheaper the annuity is to buy. And today’s low interest rates make the conversion to annuities expensive. “The interesting phenomenon is though”, he added, “that when interest rates were exceptionally high, say in the late 1990ies, people still did not buy annuities, nor did the advisers promote the idea.”

Finally, he noted the importance of discipline. He speaks from experience, and says that had he followed all the major precepts mentioned in this piece, he would be now in a much better financial position himself. “Know your needs, be prudent in your expectations, live frugally, create a plan or direction and stick to it while making adjustments, if needed,” he advises.  

We thank Dr. Por for taking the time to speak with us.

Celebrating 35 years of operations, the Saskatchewan Pension Plan is a full-service retirement plan. SPP will invest the money you contribute, and at the time you retire, gives you the option of converting your invested savings into a lifetime annuity. Why not check out SPP today?

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An old idea makes a comeback – annuities

An investment idea for retirees that you don’t hear about as often as you used to seems to be making a comeback.

A recent article in Investment Executive suggests that today’s volatile markets and uncertain economy may be perfect conditions for some of us to consider buying annuities.

An annuity is a product you purchase with all or part of your retirement savings. Once purchased, the annuity pays you a monthly amount for the rest of your life – a guaranteed amount that doesn’t change, even if markets decline. They were much more common decades ago when interest rates were high.

“Annuities are one of the best ways to plan for retirement if you are worried about volatility in the market, feel you will run out of money before you die and do not want to manage the investments,” states Markham, Ont. financial planner Ahilan Balachandran in the Investment Executive article.

He does point out that the current low-interest rate environment is not generally favourable for annuity purchases, since you basically “lock in” at a low interest rate. Annuities provide higher payouts when interest rates are higher, he explains in the article.

But it’s not all about interest rates, points out another financial expert.

“After 35 years of being in the business of selling annuities, I conclude that rates are not the primary consideration for a person to purchase an annuity,” states White Rock, B.C. annuity broker John Beaton in the article. “People are not as worried about interest rates as they are about establishing a lifetime stream of income.”

He tells Investment Executive that annuities offer “peace of mind” for retirees.

“Some people understand that a time will come when they will suffer from diminished capacity to handle their affairs. Not having to worry about how things will be paid is more important,” Beaton tells the magazine.

And Burlington, Ont. investment advisor Jim Ruta says while interest rates may be low, there are other reasons to think of an annuity.

Now that markets are so uncertain, he states in the article, “you can guarantee yourself a multiple of what interest rates are with an annuity.”

This is a somewhat complex topic. We tend to confuse retirement savings with wealth generation – for many of us, our retirement savings are the biggest chunk of cash we have. It’s never easy to think about trading some or all of that nest egg for the security of a monthly, set income.

But an annuity is a way to “pensionize” some of your savings. You saved all this money to provide future income, an annuity allows you to get a monthly pension – for life – from your savings. If you invest your retirement savings and draw it down each year, there’s a risk you can outlive that lump sum amount. That risk disappears if you have purchased an annuity.

The Saskatchewan Pension Plan (SPP) offers you a wide variety of annuity choices when the time comes to convert savings to an income stream. The SPP pensions page has details on SPP’s annuity options.

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What if there was a way to convert some or all of the money you’ve saved up for retirement into cash for life – monthly payments for as long as you live?

And once you made this conversion, you’d no longer have to make any investment decisions for this money; you’d just have to trot over to the Super Mailbox each month to collect a cheque.

There is just such a product, the annuity, but for some reason, it’s not something people choose very often. Writing in MoneySense, David Aston calls annuities “the best retirement product that hardly anyone buys,” adding that they amount to a sort of do-it-yourself defined benefit (DB) plan.

“Like DB pensions, (annuities) provide guaranteed income for as long as you live. But while employer pensions are considered the gold standard of retirement income plans, few Canadians ever think about annuities,” writes Aston, calling their unpopularity “baffling.”

Aston says that for some people, such as those with wealth or who have DB pensions from work, an annuity is probably not necessary. And others don’t like the idea of “their finality – once you give your cash to the insurance company, you’re locked in for life.” There’s no more “growth potential” for this investment and you can’t tap into it for lump sum amounts, he explains.

But, says Aston, they are ideal for cash flow. Many people buy an annuity which, along with government pensions, “meets all your non-discretionary needs,” such as keeping the lights on, the furnace going, and the rent paid via the steady, predictable and guaranteed income. And if you convert part of your retirement savings to an annuity, you can “afford to take more risks with the rest of your portfolio.”

One would imagine that those who took out annuities prior to the market downturn in 2008 are happy with their choice, because while you may miss out on investment gains, you also miss out on investment losses with an annuity.

In a video posted to Save with SPP, Moshe Milevsky, Professor of Finance at York University’s Schulich School of Business, calls annuities “insurance against something that is really a blessing, longevity.” Because the annuity pays you for life, you can never run out of money, he notes.

Writing in the Globe and Mail financial columnist Rob Carrick notes that unlike withdrawing money from a RRIF or other vehicle, the withholding tax on an annuity is not automatically deducted but is taxed the same as regular income, he explains.

He reports that a good time to consider buying an annuity is when you are older. “The later you buy, the shorter the period of time the insurer selling an annuity expects to have to pay you. As a result, payments are higher than they would be if you bought at a younger age,” he explains.

The cost of an annuity depends on current interest rates, which have been quite low for a while but are rising, which is good news for annuity buyers.

The Saskatchewan Pension Plan (SPP) is somewhat unique in that it can convert your savings into an annuity. They offer four different kinds of guaranteed annuities, and your money continues to be invested by SPP while you sit back and wait for the monthly cheque. For full details, check out the Retirement Options chapter in the SPP Retirement Guide.

Written by Martin Biefer

Martin Biefer is Senior Pension Writer at Avery & Kerr Communications in Nepean, Ontario. After a 35-year career as a reporter, editor and pension communicator, Martin is enjoying life as a freelance writer. He’s a mediocre golfer, hopeful darts player and beginner line dancer who enjoys classic rock and sports, especially football. He and his wife Laura live with their Sheltie, Duncan, and their cat, Toobins. You can follow him on Twitter – his handle is @AveryKerr22

By Sheryl Smolkin

If you are considering purchasing a life annuity using funds in your registered (RRSP, RRIF, LIRA, RPP) or unregistered accounts (Savings Accounts, GIC, TFSA, etc) you will need to consider what features to select and how your decision will impact the level of benefits you receive.

For example, a life annuity may be:

• A single life annuity based only on the age of one annuitant.
• A joint and survivor annuity that pays a portion of the benefit (i.e. 60%) until the death of the surviving spouse.
• A single or joint and survivor annuity that guarantees payments for a specific period (i.e. 10 years).
• A deferred annuity that does not start paying monthly benefits in the same year the annuity is purchased.

Other more specialized annuities include term certain or fixed term annuities, guaranteed annuities with cash back features, impaired and child inheritance annuities. You can read about them here.

To give you an idea how the nature of an annuity can impact your monthly benefits, I got a series of quotes from the RetirementAdvisor.ca Standard Annuity Calculator on October 28, 2014 which I summarized in the table below. In all cases it is assumed that a lump sum of $100,000 was used to purchase an annuity and when invested by the insurance company, the lump sum earned 4%.

While these quotes assume the primary annuitant is female and the second annuitant is male, when a male and female of the same age purchase individual life annuities, the male will receive a slightly higher periodic payment than the female because the male’s life expectancy is shorter.

Table 1: Annuity Purchase quotes

	Single life	Joint	Single Life, COLA	Joint, COLA	Single, 10 yr, COLA
Gender of primary annuitant	F	F	F	F	F
Age purchased	65	65	65	65	65
Age payouts begin	65	65	65	65	65
Gender of joint annuitant		M		M
Age when annuity purchased		65		65
Cost of living increases (COLA)			X	X	X
10 yr. guaranteed payments					X
% Payable to 2nd annuitant when 1st dies		60%		60%
MONTHLY BENEFIT	$637	$592	$522	$481	$503

	Joint, 10 yr, COLA	Single, 10 yr, COLA Age 71 start	Joint, 10 yr, COLA Age 71 start	Single, 10 yr, COLA Age 80 start	Joint, 10 yr, COLA Age 80 start
Gender of primary annuitant	F	F	F	F	F
Age purchased	65	65	65	65	65
Age payouts begin	65	71	71	80	80
Gender of joint annuitant	M		M		M
Age when annuity purchased	65		65		65
Cost of living increases (COLA)	X	X	X	X	X
10 yr. guaranteed payments	X	X	X	X	X
% Payable to 2nd annuitant when 1st dies	60%		60%		60%
MONTHLY BENEFIT	$473	$762	$719	$1,401	$1,355

Source: RetirementAdvisor.ca calculator as of October 28, 2014. Assumption: $100,000 lump sum purchase earns 4%.

It is apparent that the stripped down single life annuity pays a higher monthly amount ($637) than single or joint annuities with various combinations of guarantee periods and COLAs.

Benefit payments also increase significantly if the annuity payouts are deferred to age 71 ($762, single; $719, joint) even with a 10 year guarantee and COLAs. The payments are even higher payment if an annuity with the same features is deferred to age 80 ($1,401 single; $1,355 joint).

Furthermore, annuity payouts also vary as between insurance companies. For example, you can find current quotes from a series of insurance companies for single life annuities on a premium of $100,000 based on a guaranteed period of 5 years for both males and females on the Morningstar Canada website.

Receiving monthly annuity benefits in retirement can give you peace of mind. However, the monthly benefit you can purchase for any given lump sum varies considerable depending on the type of annuity you select, the age when you purchase the annuity, the age you begin collecting benefits and the interest rate assumptions.

Your financial advisor or an annuity broker can get quotes tailored to your situation that will help you to get the features you need for the best possible price.

You can also use your SPP balance to purchase a life annuity directly from the plan. For more information about SPP annuities, take a look at Understanding SPP annuities. Because you purchase the annuity directly from SPP, there are no commissions or referral fees and you can be sure you are getting competitive rates.

 

By Sheryl Smolkin

Receiving a regular paycheque makes it easy to budget. The amount that appears in your bank account every month is what you have available to spend on necessary and discretionary items.

But once you retire and have to figure out how to make your lump sum savings last for the rest of your life, budgeting isn’t as easy. How much can you afford to spend? What if your investments earn less than you expected when you set up a withdrawal plan?

One way to add financial certainty is to buy a life annuity with all or a part of your retirement savings. A life annuity is purchased from an insurance company for a lump sum amount and it guarantees that you will receive a set monthly amount for life (unless the annuity is indexed).

While payments from a basic life annuity typically end when you die, at an additional cost you can add provisions like a guarantee period (i.e. payments will be made for a minimum of 10 years even if you die) or a joint and survivor feature that will continue to pay out until the death of the last spouse.

Annuities are purchased from licensed life insurance agents representing insurance companies. Life insurance agents are compensated by commissions that are factored into the cost of the annuity.

Life annuities have got a bad rap in recent years because with lower interest rates they are more expensive to purchase. Also, many people do not like the idea that they lose control of their money and that upon the death of the last annuitant or the expiry of the guaranteed payment period, the principal will not revert to their estate.

However, the upside of an annuity purchase is that if you live beyond the age that it is assumed you will live to when the original annuity purchase is made, your return on investment could be much higher than if you invested the money yourself.

If you purchase an annuity with funds from a registered plan (i.e. SPP, RRSP, DC pension plan) you must begin receiving payments by the end of the year you turn 71. Because all of the money in your account has been tax-sheltered, the full amount you receive monthly will be taxed at your incremental rate.

In contrast, you can purchase an immediate or deferred annuity from a non-registered account. For example, at age 65 you could opt to manage a portion of your money for the next 15 years, but use a lump sum to purchase a life annuity beginning at age 80. Your monthly payments will be higher than if the annuity started at age 65. Furthermore, only a portion of the benefit representing investment earnings after the purchase will be taxed.

You can use the RetirementAdvisor.ca Standard Annuity Calculator (or other similar online calculators) to model either the size of the lump sum it will take to generate a specific monthly benefit or the amount of the monthly benefit a specific lump sum will generate.

Monthly benefits you receive from the Canada Pension Plan, Old Age Security or a defined benefit pension plan are in effect, life annuities. Depending on your expected expenses and the amount of savings you have available, you may decide you do not need additional annuity income.

In the conclusion to his 2013 book “Life Annuities: An Optimal Product for Retirement Income”[1], Moshe Milevsky, Associate Professor of Finance at York University’s Schulich School of Business notes the following:

“Behavioural evidence is growing that retirees (and seniors) who are receiving a life annuity income are happier and more content with their financial condition in retirement than those receiving equivalent levels of income from other (fully liquid) sources, such as dividends, interest, and systematic withdrawal plans. Indeed, with growing concerns about dementia and Alzheimer’s disease in an aging population, automating the retiree’s income stream at the highest possible level—which is partly what a pension life annuity is all about—will become exceedingly important and valuable.”

If you have rejected an annuity purchase in the past or if you have never seriously considered investing in a retirement annuity, it may be time to take another look.

You can also use your SPP balance to purchase a life annuity directly from the plan. For more information about SPP annuities, take a look at Understanding SPP annuities. Because you purchase the annuity directly from SPP, there are no commissions or referral fees and you can be sure you are getting competitive rates.

[1] This book can be downloaded in pdf and ebook format at no cost.