Annuity: A Do-It-Yourself Pension Plan

Explaining Why Canadians Should Capitalize on Annuities

Annuities are one of the absolute best retirement products that almost nobody buys. They offer a lifetime guaranteed income. Employer pensions remain the proverbial “gold standard,” as far as income plans for retirement go. Nonetheless, very few Canadians put thought into annuities and only when they want guaranteed income.

Annuity experts believe that there an effective form of protection for people who outlive their wealth (which they refer to as “longevity risk”). Suffice it to say, there are plenty of good reasons why retirees should consider annuities. Sadly, as simple as this concept is (you pay a certain insurance company for an established cash flow), its details can get complicated. While there are a number of different types to choose from, this article will concentrate on the one that is most common a life annuity that comes with a specific payout for the rest of your life. When making your decision, you’ll first have to establish if annuities accommodate your situation. You’ll also have to establish what role they will play as part of your portfolio. From there, you can decide how and when to purchase them.

Will Annuities Be Suitable for You?

One reason that people dismiss annuities involves their finality – after cash is given to an insurance company, you are locked in. By contrast, traditional bond and stock investments offer growth potential, as well as the versatility to tap into a nest egg, if necessary, for a larger sum. If you have prioritized leaving some money to heirs, annuities will preclude this option, since the payouts will stop after you die. Mind you, you do have the option to buy guarantee periods to leave annuity payments to your heirs.

With that said, annuities aren’t a black-and-white proposition. Some choose to see them as a part of one large income plan, post-retirement. Annuities work surprisingly well for portfolios alongside bonds and stocks or GICs. Your objective will be to establish the proper allocation for each asset based on trade-offs between growth potential, guaranteed income, and lump sum access.

How Much Will You Need In Retirement

You will need a withdrawal rate that is fairly conservative just in case the market performs poorly, and/or you live for a really long time (especially if you depend exclusively on a bond and stock portfolio as a retirement income). For instance, if 65-years-old is when you plan on retiring, then 4% of the initial portfolio could be withdrawn each year, in addition to inflation adjustments. With that said, some type of backup plan should be made in the event that your withdrawal rate ends up being unsustainable. Integrating annuities into a retirement strategy will be an optimal backup plan, since they will assure a fairly high withdrawal level without any depletion risk involved.

One frequently-used strategy involves using annuities in conjunction with a government pension for the sake of meeting spending requirements that are non-discretionary.

After annuities are purchased, taking more risks will be more affordable with the remainder of the portfolio. In fact, if the markets perform relatively well, and you live for quite a while, then you may end up increasing the amount of money to leave your heirs. Annuities, for the most part, should take the place of bonds in the portfolio, but there isn’t a perfect formula for this transition.

If you want the best trade-off possible between reliable lifetime income and growth, the optimal solution may involve transitioning away from fixed income altogether. In doing so, you will wind up with a combination of annuities and stocks that cater to your preferences.

Practical issues prevent people from taking things that far. Firstly, more than one short-term investment should be kept for emergency purposes. A lot of people may stress out about keeping their portfolios full of nothing but stocks. Stability is added by retaining a number of bonds, even if that means a detraction from growth.

Some see annuities as a sort of “super bond” capable of producing more income reliably over their lifetime, more so than conventional bonds can do. Insurance companies can achieve this since longevity risks are pooled by them. As such, people who die at a young age subsidize the long-livers, which are relatively few.

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When to Purchase an Annuity

Interest rates will significantly impact the payout rates that come with a new annuity purchase, which – by conventional standards – are fairly low these days. With that said, annuities will pay more as long as you can wait until you are older before buying them (something you cannot do with bonds). Waiting several years can be worthwhile since the advantage of longevity risk-pooling gets greater the older you get.

Many experts believe that the buying annuity target age is approximately 70-years-old these days. For instance, if you intend to annuitize approximately $250,000, then you may consider buying $150,000 worth of annuities now and the balance later on when you are 72 years old. Such timing may work out very well for a retiree, because they will need to convert RRSPs into annuities or RRIFs by the time the second year ends (i.e., before they turn 72 years old). It will be convenient for them to have registered funds annuitized at that particular time. On that note, if annuities are purchased with registered money, the whole payout will be taxable – like RSP or RRIF withdrawals. As far as non-registered money is concerned, you can purchase life annuities, which are subject to tax on the interest payout only (as opposed to the capital return amount). Of course you need to consider your health when making these decisions.

How to Purchase an Annuity

Keeping in mind the financial sector’s penchant for product promotion, it is surprisingly difficult to locate someone to buy annuities from. While annuities are a type of investment product, they’re sold exclusively by people who have insurance licenses. That means investment advisors won’t have the ability to sell you an annuity, despite their best intentions (unless they’re dual-licensed). Further, annuities pay out lower commissions in comparison to mutual funds, among other investments. As such, advisors must overlook any self-interest they have and convince you to possibly convert a portion of your existing nest egg over to annuities.

You can get in touch with an annuity broker that works independently if you happen to know what to purchase, but finding one is easier said than done. You may also be able to find an agent that has an insurance company affiliation, and if you do, make sure that the quote that you get is competitive. To integrate annuities into the portfolio you own, speak to a licensed investment advisor – one that uses annuities in appropriate situations. If the advisor you speak to is unable to do that, then think about using somebody else.

It will take some effort and time on your end to figure out an annuity method you are comfortable with, but do so knowing that the rewards will be worthwhile.

How Buyers Can Shop around for Annuities

Receiving annuity quotes from multiple insurers can go a long way towards saving you money. “Quotes can differ by more than 10%”, says Ivon T. Hughes of LifeAnnuities.com. You can also find key rates regularly published in several different newspapers.

Getting a Guarantee

A lot of senior citizens have concerns about succumbing to injury or death right after purchasing an annuity. They don’t want to leave their heirs empty-handed. Annuities are usually sold as guaranteed payments that will last for a specific amount of time. Payments will continue to be made until the other spouse passes away if a joint annuity is involved.

Guarding Against Inflation

Regular fixed annuities are susceptible to inflation. However, payouts that are indexed on the “Consumer Price Index” happen to be expensive and rare. A solution that is more cost-efficient would be to have your bank automatically transfer 5% of each monthly payment into a savings account. The accumulated amount could then be used to purchase another annuity. The purchasing power will be protected as you will be older when purchasing the second annuity.

Insuring the Insurer

If you purchase an annuity, you trust that an insurance company will make your expected payments, and do so for decades. Choosing a large, well-capitalized, and well-established insurance company would be prudent. The insurer should be a part of Assuris, a guarantor that is industry-sponsored. You should stay within the guarantee’s limits, which is a maximum of $2000 per month.

As with all major investments, you should seek advice from a life annuity broker and other independent advisors to help you make the best choice. Speak to them about how annuities can work for you and what options would be advisable for you.

• Click Here To Find Out How Much An Annuity Will Cost