The volatile stock market is enough to give nightmares to investors hoping for a nice retirement nest egg. If you wish there was a way you could be assured of steady income after retirement without the uncertainty of the stock market’s ups and downs, you should learn about annuities.
You won’t have to worry about bear markets and crashes if annuities from trusted insurers such as Sun Life Assurance, Canada Life, RBC Insurance, Desjardins, or Bank of Montreal are part of your investment portfolio. Adding an annuity to your investment portfolio will add safety and certainty to your retirement planning.
But how much of your portfolio should be in annuities? Read on to find out.
What Is an Annuity?
An annuity is a financial concept dating back to ancient Rome. With soldiers rewarded with lifetime annuities for their service, annuities still provide security for retirees today.
Think of an annuity as insurance against outliving your retirement savings. With insurance and savings, annuities can complement retirement accounts because of the certainty of their growth and tax benefits.
In simple terms, an annuity is an insurance product offered by Canadian insurance companies where you give a lump sum amount of money to the insurance company and they will guarantee to pay you an income (typically monthly) for the rest of your life. With a life annuity, you will receive income payments as long as you live.
Types of Annuities
Annuities come in a variety of styles, making them suitable for any risk tolerance. Some investors may want to combine several types of annuities within their portfolios. Among the types of annuities are these:
One of the benefits of annuities in Canada is that they are quite customizable and can be tailored to fit your needs. There are two main types of annuities available to purchase- life annuities and term certain annuities. See below for more information…
Single Life Annuity
A single life annuity is based on one annuitant. Income payments from the insurance company are guaranteed for the annuitant’s entire life. The money used to purchase the annuity can come from several different sources which include RRSP, RRIF, Non-Registered, Registered Pension Plan and more. The payments can start immediately once the funds have been received by the insurance company or they can be deferred to start at a later date.
Joint Life Annuity
Very similar to a single life annuity, but a joint life annuity is based upon two lives instead of one. Income payments from the insurance company are guaranteed until the 2nd death of the two annuitants. As mentioned above with a single life annuity, the money used to purchase the annuity can come from a number of different sources which include RRSP, RRIF, Non-Registered, Registered Pension Plan and more. The payments can start immediately once the funds have been received by the insurance company or they can be deferred to start at a later date.
Since a joint life annuity covers two lives, you can structure the annuity so that the payments can change upon the 1st death. You can have the annuity setup so that if one of the annuitants passes away, the surviving annuitant will receive 70% of the original payment for the rest of their life. If you have a reducing payment upon the 1st death, you will have a higher initial payout.
Term Certain Annuity
A term certain annuity provides payments from the insurance company for a specific period of time. For example, a 10 year term certain annuity would provide guaranteed payments for 10 years at which point the contract would be complete. These can also be purchased with funds coming from numerous sources.
You may want to consider a term certain annuity if you are trying to bridge your income for a period of time and current interest rates are favourable. There are different reasons for considering a term certain annuity which should be discussed with a professional.
Options and Riders
We covered the main types of annuities available in Canada above, but there are a number of different options/riders which you can add to these annuities depending on what you are requiring for income and your lifestyle. These riders can include guarantee periods, index/inflation protection, return of premium, deferral periods and more.
How Much of My Investment Portfolio Should Be in Annuities?
There is no one answer to the question of how much of an investment portfolio should be in annuities. Determining the allocation of your portfolio depends on your unique needs and goals. Among the factors to consider are the following:
Your Age
Your annuity income is affected by how old you are now and when you want to start drawing income. The longer you hold an annuity and the older you are when you begin to receive income from your annuity, the higher your payments will be.
If you retire early, you will spend more of your assets to get the same amount of income each month. So the closer retirement is, the more cautious an investor should be.
Your Savings
You can buy an annuity for a minimum of $10,000, but to gain a significant amount of retirement income from annuities, you will need to invest more (e.g. $50K, $100K, $200K, $500K, etc.)
Some investors will opt to build an annuity ladder, spreading out annuity contracts over time, allowing investors to save for annuities between purchases and take advantage of rises in interest rates between annuity purchases. This is very similar to dollar cost averaging with an investment account (mutual funds for example).
Your Risk Tolerance
Some handle the risks of investing better than others. For the risk-averse investor, an annuity could provide the security you need to feel comfortable about your retirement savings. It is very common for annuities to be purchased to ensure that your fixed expenses in retirement are at least covered. This provides great peace of mind for many Canadians.
Investors with higher risk tolerances can also use annuities as a part of their portfolio. An annuity could take the place of the fixed income portion of a portfolio and allow the remainder of the funds to be invested aggressively to try to get the highest return possible.
Taxes
Annuities can deliver investors benefits since they are not taxed until monthly payments are received. With the different types of annuities available, we suggest consulting with us to understand how a specific annuity is taxed.
How to Determine the Right Percentage of Annuities
Investment advisors often say a portfolio for an investor nearing retirement should be 40 percent stocks and 60 percent bonds to provide safe investments and growth. However, investors can use annuities in place of bonds to have even more certainty.
Some experts in investments and annuities recommend making your portfolio 50 percent annuities to provide safety in volatile markets. For investors with higher risk tolerances, the security of fixed annuities can free them to invest more aggressively with the other half of their portfolios.
Every investor has unique needs and should discuss their risk tolerance and goals with a financial professional before making any decisions.
Conclusion
The best way to learn more about the percentage of your portfolio that should be in annuities is to talk with an investment advisor. We’ll listen to your retirement goals and work with you to find the best annuities for your portfolio at a percentage that will provide growth with guaranteed returns.
Contact us today for a free, no-obligation consultation to find out how annuities can take the risk out of retirement.