Declining interest rates are great for borrowers, but they take an axe to returns for people who want to avoid putting their money at risk.
Retirees, for example. Top guaranteed investment returns have fallen from the 5-per-cent to 6-per-cent range a year ago to the mid-4-per-cent range for a one-year term and 3 per cent to 4 per cent for five years. Returns from additional safety-first options such as T-bill funds, investment savings accounts and high interest savings exchange-traded funds have declined similarly.
Annuities have also been affected by lower rates, but you could still get a lifetime yield of 5 per cent as of recently. What’s lifetime yield? It’s a way of looking at annuity returns that was used recently by Clay Gillespie of RGF Integrated Wealth Management to make a point.
“I think annuities deserve a bigger place in retirement planning,” Mr. Gillespie, a veteran financial planner, said in an e-mailed introduction to an article on the benefits of annuities held in registered retirement income funds or registered retirement savings plans.
A life annuity is an insurance contract where you exchange a lump sum of money for a guaranteed stream of lifetime income that is usually paid monthly. Basically, you’re buying your own pension.
It’s hard to say what the actual return is from an annuity because you don’t know how long you’ll live. What Mr. Gillespie did was calculate returns based on life expectancy.
Considering annuities for retirement income? Here’s where to get quotes
Here’s an example of how the lifetime yield calculation works based on a male aged 65 who invests $100,000 in an annuity paying $582 a month and has a life expectancy of 21 years. If this same person had $100,000 in a RRIF and withdrew $582 a month for 21 years or so, the annual yield would be about 5.3 per cent.
The comparable lifetime yield for a 65-year-old woman would be 5.5 per cent, a calculation that Mr. Gillespie based on a life expectancy of 24 years and monthly annuity payments of $544 a month. Life expectancies in these examples come from the Canadian Institute of Actuaries and reflects the experience of people in pension plans.
The monthly $582 and $544 monthly annuity quotes were obtained by Mr. Gillespie in mid-September, several days after the latest interest rate cut by the Bank of Canada. Interest rates of various types influence annuity payout rates, but there are other factors. One of them is mortality credits, a term for money that was invested in annuities but only partially paid out because the annuity holder died.
This brings us to a legitimate reason why annuities remain a fringe retirement product. If you die in the years shortly after buying one, you end up having sacrificed a chunk of your savings to buy a short-term flow of income.
Mr. Gillespie based his examples of lifetime yield on an annuity that is guaranteed to pay out for five years. If you die during that period, a beneficiary or your estate would get the money. Still, though, it’s not a great outcome if you invest $100,000 in an annuity that only pays out for five years. For this reason, annuities should only be used for a portion of your retirement savings.
But dwelling on the risks of dying young is counterproductive. Actuarial data suggests people who have made it to age 65 in reasonable health should be more concerned about outliving their savings as opposed to dying young and leaving money on the table.
Mr. Gillespie offers a tax argument that further supports the idea of a registered annuity – you can also buy non-registered annuities, but he’s not as keen on them. Investments held in RRIFs are inefficient in that they are fully taxed when you die, unless rolled over to a surviving spouse. In some cases, more than 50 per cent of the RRIF assets will go to the government.
With an annuity, you use assets in your RRIF to produce a level income over your lifetime. “You should be able to withdraw most of the funds at a lower tax bracket and not worry about running out of funds,” Mr. Gillespie writes.
How much should you put in an annuity? Mr. Gillespie suggests enough to cover day-to-day expenses when combined with Canada Pension Plan and Old Age Security.
Part of the reason for limiting use of annuities is the loss of control over your money. Another reason is that while annuities can be bought with inflation indexing, Mr. Gillespie doesn’t think they’re a good value as a result of the lower payouts. Solution: Protect against inflation with the rest of your investments through exposure to the stock market and dividend growth stocks.
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