Combining a RRIF with an Annuity

Combining a RRIF with an Annuity

A Registered Retirement Income Fund is meant to provide a good source of income for retirement. However, Canadians are living much longer today than they did in the past.

Statistics Canada data indicates the average life expectancy of a Canadian in 1981 was 74.83 years. Today, it has risen to 82.66 years. However, these are averages and some individuals live much longer.

This is a very real problem. Hundreds of thousands of Canadians surpassed 85 years of age in 2020 and the average life expectancy also increases each year due to improved healthcare and greater diet and exercise awareness.

As a result, many Canadians now find themselves living a very productive life for decades longer than originally projected. However, they may have enough regular income to pay their fixed expenses such as mortgage payments, food, insurance, and utilities for these extra years.

Bridging the Income Gap

A 2021 Angus Reid poll found 63% Canadians are worried they won’t have enough money to support themselves in retirement. Even those with an established retirement income fund who thought they were well-funded, for retirement could discover their RRIF payments won’t last through their lifetime.

A RRIF is designed to slowly deplete over the years through mandated withdrawals. The minimum withdrawal amount increases each year as the retiree ages. By the time they reach their mid-90s, withdrawals are 20 % of their RRIF annually. Once that money’s out of the fund, the investor can’t recontribute and probably doesn’t have the resources to do so anyway.

Considering the economic strain of the pandemic, it is quite possible that some retirees could find themselves without sufficient money for expenses when they should be enjoying their retirement. The same poll found 43% of all Canadians are currently financially challenged or suffering due to the pandemic.

One possible solution is to move part of the funds in a RRIF into a life annuity. An annuity can provide the permanent income needed that an RRIF can’t provide.

What is an Annuity?

An annuity is a financial product that provides a fixed income payment. It is essentially an insurance policy with a set amount of money paid annually or monthly for life and normally contracted period of time.

These income payments consist of a combination of interest earned, a return on capital invested, and transfers of capital from those that die earlier than statistically calculated to those that live longer. Annuitants who live beyond the average life expectancy receive more than those who do not.

Investors can choose an annuity for a fixed period (term-certain), or for life. In some cases, an annuity can also offer a portion of the payments or all of the payments to a spouse or partner after the death for a prescribed length of time.

Many types of annuities exist, each with pros and cons. Registered annuities (created with funds from a RRIF, RRSP, etc.) offer income up to age 90. Non-registered funds can provide income guaranteed to last beyond age 100.

The payment amount of an annuity depends on factors such as age, gender, length of the term, amount invested, the annuity provider, and the current interest rates. Higher interest rates typically lead to higher payments. Even if interest rates drop later, the payment amount is locked in for the duration of the contract.

It is important to remember that bonds in retirement portfolios will underperform if interest rates rise. Conversely, an annuity can provide a steady income regardless of interest rate changes.

Life Annuity

As the name suggests, a life annuity provides guaranteed lifetime income. Moving a portion of funds in a RRIF into an annuity could potentially eliminate the possibility of outliving RRIF income payments.

A life annuity may also include options that allow payment transfers to a partner or spouse. It may also provide an option to transfer payments to a beneficiary or the estate after death through a joint or survivor option. These payment transfer options usually reduce the payment amount. This can be a good trade-off in some cases if the option aligns with the retiree’s priorities.

More Life Annuity Options

This isn’t the only option if transferring wealth to a partner or beneficiary is of primary concern. Investors can retain a portion of their money in their RRIF or TFSA instead.

A life annuity offers the greatest benefit when the contract holder lives a long life.

Term-Certain Annuity

A term-certain annuity offers guaranteed income payments for a fixed length of time such as 5, 10, 15, or 20 years. Payments can transfer to a beneficiary or an estate after death.

However, choosing a term-certain annuity may not eliminate income uncertainty. If the annuity holder lives longer than the term length, income payments would stop.

Nonetheless, a term-certain annuity can be a good choice in certain circumstances. For instance, it can bridge an income gap until the individual starts to receive benefits from other sources such as a defined benefit pension plan, deferred profit-sharing plan, Old Age Security, Canada Pension Plan, or Quebec Pension Plan.

Variable Annuity

A variable annuity relies on underlying investments with a variable return, such as equities or the stock market. This can potentially produce higher returns, but it also involves more risk.

Income payments are directly linked to market performance, making it difficult to predict payment amount. If the variable portion of the annuity performs poorly, the investor could potentially make less than through a non-variable product. Consequently, a variable annuity probably isn’t the best choice if an investor wants to generate a steady, reliable income.

Advantages of an Annuity

Moving part of a RRIF to an annuity does offer specific benefits. However, it is best to do so under the advice of a financial advisor, because annuities also include some drawbacks. Balancing the pros and cons depends on your financial position and risk tolerance.

1. Solid Income Source

Dependability and predictability are two principal benefits of an annuity. It can guarantee a certain level of income at precise times throughout the term, regardless of interest rate changes or market volatility.

Annuities are suitable for investors with a low risk tolerance. Additionally, registered annuities will almost invariably provide a higher retirement income than a RRIF.

LifeAnnuities.com online annuity calculator can help investors understand how much they might expect from an annuity. However, advice from an investment professional is definitely recommended. With so many products available from multiple providers, it is vital annuity payments align with expenses to provide the income needed in retirement.

2. Simplicity

After investing in an annuity, the individual does not need to rebalance their contract or worry about whether they will enough income. It is essentially hassle-free. Once the investor decides on the annuity, the policyholder receives their payments automatically at specified times.

Conversely, a RRIF must be managed since it relies on underlying investments such as equities or the stock market.

3. Protection Against Loss

Annuities are life insurance products. Canadian annuity policyholders are protected under the consumer protection agency, Assuris. This agency ensures policyholders receive a portion of all of their payment should the provider fail. The percentages are as follows:

· 100% of monthly payments up to a maximum of $2,000 (Update: as of May 25, 2023, Assuris guarantees a maximum of $5,000)

· 85% of monthly payments over $2,000 (Update: as of May 25, 2023, Assuris guarantees 90% of monthly payments over $5,000)

Considering the state of the world and the potential volatility of the stock market during these troubled times, this safety net is a welcome extra.

4. Flexibility

Investors can buy an annuity from a variety of income sources, as well as their RRIF. Providers offer many options such as term-certain annuities that guarantee payments with a timeframe or to a beneficiary or estate after the annuitant's death.

Other options include inflation protection with an indexed rate based on the movement of a particular benchmark as well as single or joint contracts.

Disadvantages of an Annuity

All investment products have advantages and disadvantages. Sound financial planning depends on choosing what is best for an investor’s goals, lifestyle, and risk tolerance level. The following are potentially negative aspects of annuities investors should consider.

1. No Control Over Investment Mix

An annuity offers a guaranteed level of income, but the policyholder does not control their investment mix. Investors that want to retain control over their investments may find this a disadvantage.

2. Fixed Contract Terms

Buying an annuity includes signing a contract. Once signed, the terms are fixed and the funds locked in. The investor can’t switch to another annuity type or company, make ad hoc withdrawals, or ask for a refund.

3. No Liquidity

As mentioned, an annuity locks in capital. However, this is only an issue if an investor’s entire portfolio is invested in annuities.

An annuity can be an excellent choice for an investor when they need to cover fixed expenses above income earned through CPP/QPP, OAS and defined benefit pension plans (DB).

Relying on market-linked investments can’t guarantee future fixed expenses can be paid, especially in a volatile market. However, investing a portion of funds in an annuity and a portion in the stock market could balance income and investment goals.

4. May Not Offer Full Value

Annuities offer the most benefit the longer the annuitant lives. However, the potential exists that a policyholder may not live long enough to recoup all the money invested in the annuity.

Nonetheless, when a policyholder surpasses the break-even point of their contract, they recoup their original premium and continue to receive additional payments. A financial advisor can let the investor know how long this will take for particular products to fully-understand whether annuities suit their needs.

5. Potential Tax Implications & Fees

Taxes paid on an annuity depend on whether it is held in a registered or non-registered account. Income from a registered annuity is 100 percent taxable to the policyholder in the year it’s received. Only the interest earned on non-registered annuity income is taxable.

Balancing a Portfolio

Converting a portion of a RRIF to an annuity is much like creating an additional pension plan payment. It can be used to supplement other income streams such as government pensions and an employer defined benefit plan. Funds left in the RRIF can be managed independently and used for portfolio growth.

Annuities should be considered a tool. When used wisely, they can greatly benefit an investors retirement income plan and can easily work alongside stocks, bonds, and GICs. It is not a matter of choosing one over the other. Rather, investors need to balance guaranteed income, growth potential, and liquidity.

A potential scenario might be to move approximately 25% of retirement income assets to a life annuity. The remaining 75% can remain in RRIF investments for liquidity and growth.

However, this is just an example. Balancing a portfolio requires expertise. If guaranteed income is a concern, life annuities can provide sound ground. Our personalized service, years of experience, and access to a broad range of products ensure you make the best possible financial decisions.

We understand every individual has distinct financial requirements due to their life circumstances. A single person without a partner or dependents certainly wouldn’t need the same financial products as a family man that wants to guarantee an inheritance.

Let us connect you with one of our experts in annuities and Registered Retirement Investment Funds. We also offer Wealth Planning expertise to help you build, protect, and transition your finances for the future.

Our independent advisors provide unbiased advice and represent many companies. They also have a fiduciary duty to protect your interests. Contact us for a free consultation. You can have peace of mind and the income you need during retirement.

What to do now?

• We supply you with the best investments in Canada as our brokers represent all the best financial institutions in Canada. For personal assistance on your RRIF or Annuity please use our RRIF Form or Annuity Form.