Annuities are just one tool in your arsenal
One of the first questions many of my high net worth clients ask me is whether they’ll outlive their money. Now, if someone comes to you with $500,000 to $1 million to manage, you’d think they’d be feeling pretty comfortable. You’d be wrong. It’s all a matter of perspective. These days, to maintain the kind of lifestyle you’re used to in retirement, you pretty much have to plan to the age of 100. It sounds incredible, but it’s true. So if you retire at, say, age 60, you’d have to fund another 40 years of retirement with that million bucks. Suddenly, it doesn’t sound like so much.
Living longer, paying more
Yes, I know 100 sounds like an unattainable age, but according to the demographic trends identified in the last census, Canada could have more than 17,000 centenarians by 2031. You may be one of the lucky few who live past age 90, even to 100, so it is important to plan for a long life while you are still able to make strategic investment and spending choices.
The fact is that with age, our health declines and healthcare costs rise. You can never tell if you will need even more extensive healthcare later in life. If you are a pre-retiree, you are at a point in the planning stage where you are shifting away from the accumulation of a retirement nest-egg to generating income and preserving capital. Your investment asset choices should reflect this change.
The three streams of retirement income
You can think of your retirement income as coming from three different sources. First is pension income from government sources, like Canada Pension Plan and Old Age Security, from employer-sponsored defined benefit pension plans, or from annuities. These typically provide a pre-set stream of income over which you have little or no control.
Next are registered accounts like Registered Retirement Income Funds, which mandate a minimum annual withdrawal, Tax-Free Savings Accounts, and income-producing non-registered investment accounts or mutual funds. You have some measure of investment control over all of these assets.
The third source may be a product with a guaranteed withdrawal benefit, providing guaranteed income as well as exposure to the stock market. These are also offered by insurance companies but are not classed as annuities.
The GIC mistake
Many people getting ready to retire make the mistake of first looking for safety of capital in investments like guaranteed investment certificates. However, the exceptionally low rate of return on GICs is a major shock. Five-year GIC rates are currently around 2.6% annually. With inflation about 1.5%, your real return is 1.1%. Taxes eat into that even more. On the other hand, a straight single-life annuity with a 5-year guarantee is currently paying out at over 6% annually.
So why aren’t annuities more popular? An annuity is basically a contract you buy, usually from an insurance company, under which the company guarantees you’ll receive a specified income flow for a specified period of time. Standard annuities are not designed for growth or residual value. They’re designed simply to pay out the agreed income for the duration of the contract. If you die before the contract ends, the residual will go to your beneficiaries, but that may not be much. If the contract expires before you die, the payments end and there typically is no residual.
Annuities as just one income tool
However, as I mentioned above, annuities are not an all-or-nothing proposition. They are simply one retirement income option that you can combine with others to suit your needs. Indeed, there are several kinds of annuity strategies as well, including laddering strategies and insured annuities, that can increase their flexibility as part of your retirement income plan and as part of your estate plan.
You can see that while it has become more important to plan for a longer retirement, there are also many products that can provide income streams while protecting capital and minimizing risk. There are many innovative strategies available to combine these products to maximize income. Your best bet is to speak to a financial advisor who is qualified in both securities and insurance products to help you build an income plan that best meets your retirement needs.
© 2014 by Robyn K. Thompson. All rights reserved. Reproduction without permission is prohibited.
