The last federal budget introduced advanced life deferred annuities (ALDAs), a vehicle similar to a regular life annuity except that payments start later in life. In fact, they can start as late as the age of 85 though you have to pay for it now. Your initial reaction might be: “Great, I didn’t care for annuities when payments started immediately so why am I going to like them any better when payments start around the time I expect to die?”
So far, the most commonly cited reason in favour of buying an ALDA is to reduce the amount you must withdraw from your registered retirement income fund (RRIF). This is also about the lamest reason. Statistics suggest that most retirees draw down their nest eggs too slowly, not too quickly. Unfortunately, they won’t come to realize that fact until it is too late.
The best, and maybe only, reason to consider an ALDA is that you think you might live a long time and don’t want to worry about where the money will come from. But is an ALDA the best solution in this case? To address this question, let’s consider an example.
My friend Pete just turned 65 and his wife Cathy is 62. They have $500,000 in registered retirement savings plans (RRSPs) and another $100,000 in tax-free savings accounts (TFSAs). They also have a paid-off house, no debt and both are entitled to Canada Pension Plan (CPP) and Old Age Security (OAS) pensions. In other words, they are in good financial shape for a middle-income couple on the verge of retirement.
Pete and Cathy decide to draw retirement income of $62,000 a year. This figure includes OAS and CPP pensions, which they start immediately upon retirement. Their plan is to increase the total draw in future years to reflect inflation.
Alas, the investment returns on their registered retirement income fund, or RRIF (which is where they transfer their RRSP) are poor, averaging only 2.7 per cent over the course of their retirement period. Monte Carlo simulations, also known as multiple probability simulations, indicate there is only one chance in 20 of such a poor return from a balanced portfolio, but it is still possible. Without an ALDA, their RRIF and TFSA assets are totally exhausted by the age of 83, leaving them only with government pensions. This is shown in Chart 1.
Condo buyer’s guide: When to buy, how to finance and advice on hidden costs
Four ways advisors can help business owners transfer their business
Can this couple successfully navigate an unexpected early retirement?
Running out of money
without an ALDA
$100,000
Secure income (CPP, OAS)
Variable income from RRIF, TFSAs
75,000
Retirement income
50,000
25,000
0
65
67
69
71
73
75
77
79
81
83
85
87
89
91
93
Age of older spouse
JOHN SOPINSKI/THE GLOBE AND MAIL
SOURCE: Frederick Vettese
Running out of money without an ALDA
$100,000
Secure income (CPP, OAS)
Variable income from RRIF, TFSAs
75,000
Retirement income
50,000
25,000
0
65
67
69
71
73
75
77
79
81
83
85
87
89
91
93
Age of older spouse
JOHN SOPINSKI/THE GLOBE AND MAIL
SOURCE: Frederick Vettese
Running out of money without an ALDA
$100,000
Secure income (CPP, OAS)
Variable income from RRIF, TFSAs
75,000
Retirement income
50,000
25,000
0
65
67
69
71
73
75
77
79
81
83
85
87
89
91
93
Age of older spouse
JOHN SOPINSKI/THE GLOBE AND MAIL, SOURCE: Frederick Vettese
What if they had opted instead to buy an ALDA at 65 with 15 per cent of their RRSP assets (that is, $75,000)? The payments from the ALDA would begin at 85. As Chart 2 shows, they are now much better off than without the ALDA. From 85 and on, the ALDA provides substantial income for the rest of their lives. What’s more, it is highly secure income.
The situation is not perfect, of course. Income for Pete and Cathy falls well short of their needs between the ages of 80 and 85. The shortfall is severe enough to force them to take drastic action such as selling off their home at a time of life when people are loath to move. And even after 85, their income is lower in real terms than what it was before 80.
An ALDA helps but...
$100,000
Var. income from RRIF, TFSAs
CPP+OAS pensions
ALDA
75,000
Retirement income
50,000
25,000
0
65
67
69
71
73
75
77
79
81
83
85
87
89
91
93
Age of older spouse
JOHN SOPINSKI/THE GLOBE AND MAIL
SOURCE: Frederick Vettese
An ALDA helps but...
$100,000
CPP+OAS pensions
ALDA
Var. income from RRIF, TFSAs
75,000
Retirement income
50,000
25,000
0
65
67
69
71
73
75
77
79
81
83
85
87
89
91
93
Age of older spouse
JOHN SOPINSKI/THE GLOBE AND MAIL
SOURCE: Frederick Vettese
An ALDA helps but...
$100,000
CPP+OAS pensions
ALDA
Var. income from RRIF, TFSAs
75,000
Retirement income
50,000
25,000
0
65
67
69
71
73
75
77
79
81
83
85
87
89
91
93
Age of older spouse
JOHN SOPINSKI/THE GLOBE AND MAIL, SOURCE: Frederick Vettese
To avoid this income gap, they could have spent less from the outset but as we will see, they don’t have to. Instead of buying an ALDA, Pete and Cathy could wait until 70 to start their CPP pensions and thereby receive 42 per cent more than CPP would pay at 65. Of course, this deferral forces them to draw down their RRIF assets more quickly before 70 but the result, somewhat counterintuitively, is greater income security in the long run. This is shown in Chart 3.
...Deferring CPP to 70 works better
than an ALDA
$100,000
Secure income (CPP, OAS)
Variable income from RRIF, TFSAs
75,000
Retirement income
50,000
25,000
0
65
67
69
71
73
75
77
79
81
83
85
87
89
91
93
Age of older spouse
JOHN SOPINSKI/THE GLOBE AND MAIL
SOURCE: Frederick Vettese
...Deferring CPP to 70 works better
than an ALDA
$100,000
Secure income (CPP, OAS)
Variable income from RRIF, TFSAs
75,000
Retirement income
50,000
25,000
0
65
67
69
71
73
75
77
79
81
83
85
87
89
91
93
Age of older spouse
JOHN SOPINSKI/THE GLOBE AND MAIL
SOURCE: Frederick Vettese
...Deferring CPP to 70 works better than an ALDA
$100,000
Secure income (CPP, OAS)
Variable income from RRIF, TFSAs
75,000
Retirement income
50,000
25,000
0
65
67
69
71
73
75
77
79
81
83
85
87
89
91
93
Age of older spouse
JOHN SOPINSKI/THE GLOBE AND MAIL, SOURCE: Frederick Vettese
It turns out that deferring CPP to 70 is a better solution than buying an ALDA, at least for Pete and Cathy. They can now maintain their higher spending for life. Notice as well that they derive almost all of their income in their later years from highly secure sources. No more having to worry about the ups and downs of the capital markets.
As good as that sounds, almost no one defers CPP until the age of 70. Most people hate the idea of leaving money on the table in the event they die early but if this fear is driving their decision-making, then an ALDA is not for them either.
The analysis suggests that ALDAs are not the best solution for middle-income couples with significant CPP pensions. In fact, they aren’t great for anyone as long as interest rates stay so low.
Still, there are some situations where people can benefit from ALDAs; in particular higher wealth individuals, meaning those with seven-figure asset balances. Also likely to benefit from ALDAs are middle-income couples with less CPP than Pete and Cathy. In such cases, deferring CPP is a useful strategy but not enough to provide total security late in life.
High wealth individuals could, of course, buy old-fashioned immediate annuities to augment their income from secure sources but it is hard to sacrifice 25 per cent or more of one’s RRSP assets to accomplish that goal. For higher net worth households, the beauty of an ALDA is that you need to spend just 5 per cent or 10 per cent of your RRSP assets to receive substantial income after the age of 85.
Frederick Vettese is the former chief actuary of Morneau Shepell and the author of the book Retirement Income for Life
