Annuities

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People who save through RRSPs have a choice to make when they retire. They can transfer their RRSP balance to a RRIF and draw it down at their own pace (subject to a minimum) or they can buy an annuity.

Buying an annuity is an elegant solution since it removes the risk of outliving one’s assets (what actuaries like to call “longevity risk”).  It eliminates the hassle of making investing decisions after retiring and the income stream it provides is very safe.  
Annuities become increasingly attractive as you get older. 

Annuity “paycheque” key to happiness 

You may have seen headlines such as “LifetimeIncome Stream Key to Retirement Happiness”, and “Happinessin Retirement is a steady income”.  According to Towers Watson, people with annuitized income are happiest, compared to retirees with similar wealth and health characteristics. 

And according to the CD Howe Institute, most middle and high-income earners would likely benefit from directing some of their savings into a life annuity.  Ninety-seven percent of Canadians say they want some of their retirement income guaranteed, according to TheSun Life Canadian Unretirement Index Report

An annuity can help you cover your basic retirement expenses, no matter how long you live.  Or it can replace the fixed income portion of your investment portfolio with a much higher cash payout. Let’s say your RRIF is invested 50% in equities and 50% in fixed income. Why not buy an annuity with half the money and then invest the remaining portion 100% in equities? The annuity replaces the fixed income investments and provides a perfectly stable income stream at the same time.   You can then focus on the retirement lifestyle that makes you truly happy. 

Payout annuities can provide the highest level of guaranteed monthly income in retirement, and deliver protection from market volatility.  But most people (62% of Canadians) don’t understand how they work.  The following video provides a primer as to how annuities work: 



Annuities: suitability and benefits 
  • Annuities provide an income stream or “paycheque” that is guaranteed for life in return for one or more premiums paid to an insurance company
  • Immediate annuities are suitable for ages 60 and over.  You can begin your “paycheque” immediately.  Buying an annuity is like creating your own personal pension plan
  • Annuities are available with many options such as cash refund, guaranteed number of payments to heirs if you pass away, indexed, and joint last to die
  • You can create an annuity “ladder” by purchasing several spread over several years.
  • An annuity can be combined with an insurance policy to ensure that money is left behind for heirs
  • Annuities can be purchased with RRSP or RRIF money, or with non-registered funds.  If the premium is paid with non-registered funds, these annuities provide very tax-efficient income – with only about 10% to 20% of the income taxable, depending on the circumstances.  By comparison, 100% of the income from GICs and bonds is taxable. 
7 things that affect annuity income

Your annuity income is calculated at the time you buy the annuity. It’s based on a number of factors. The most important ones are your life expectancy and interest rates. If you’re buying a life annuity, the insurance company uses insurance tables to project how long you are likely to live.  

Factors that will affect your annuity income.  

1. Your age: The older you are when you buy the annuity, the higher your annuity payments will be. That’s because you’re not expected to live as long.  The best time to buy an annuity is between the age of 60 and 71.  The older you are, the more that your age affects the rate you will get. 

2. Current interest rates: If interest rates are high when you buy your annuity, your annuity payments will be higher than if interest rates were low. That’s because the financial institution predicts it can earn more by investing your money.  The older you get, the less important the interest rate is in determining your payout, compared to the importance of your age. And as people are living longer, the effect of higher future interest rates may be offset by lower rates due to increased life expectancy.  One strategy that can be used to mitigate this effect is to ladder your purchase of annuities – in other words – buy several annuities over a period of several years. 

3. Your gender: Women get less money than men of the same age because they are expected to live longer.

4. The amount you deposit: The more money you put into your annuity, the more you get back as income.

5. The length of time the payments are guaranteed:  If you have a life annuity, you can arrange for your annuity payments to continue to your spouse, your dependent children, or your estate after you die. The longer you want payments to continue after your death, the less you get each month while you’re alive.

6. The options you add:You get the highest income with a basic annuity that covers only you. Any options you add (like a joint-and-last survivor option) will lower the amount of your payments. That’s because these extras increase the costs to the insurance company.

7. If you have a serious medical condition: Some life annuity providers will also factor poor health into an annuity quote if you have a serious medical condition. This means your annuity payments will be higher because your life expectancy is shorter.

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