One day you will need to shut down your RRSP. It's mandatory to do so by the end of the year you turn 71. One day you will need retirement income. How will you reconcile the two?
Transferring RRSP holdings to a registered retirement income fund (RRIF), investing the money in income-generating investments and making regular withdrawals is the road that many retirees take. The investments must be managed to ensure sufficient cash is available to pay out the target withdrawal. This figure must be no less than the government-specified minimum, an amount which increases every year.
The RRIF route involves taking risks. The RRIF investments you hold could perform poorly and fail to generate enough income. At some point, you may no longer be capable of making decisions about your investments. You could run out of money if you live longer than expected. Inflation could destroy the purchasing power of your RRIF income.
Buying an annuity can address these risks.
An annuity is an insurance product. You pay a lump-sum premium to an insurance company and, in return, receive regular (monthly, quarterly, semi-annual or annual) guaranteed income payments for a specified time period. Some or all of your RRSP, RRIF or other registered retirement funds can be used to buy a registered annuity. A non-registered annuity can be purchased with other savings.
After buying an annuity, there are no further investment decisions to make.
An annuity transfers the risk of running out of money to the insurance company for the time period of your choosing.
A term-certain annuity pays regular income for a defined number of years. This type of annuity could prove useful if you retire early and need a regular income until your pension starts.
A single-life annuity makes payments until the annuitant dies. Income from a joint-life annuity continues as long as the annuitant or her spouse is alive. A payment guarantee period of up to 25 years can be added. If the annuitant dies during that time, the named beneficiary receives the payments for the remaining guarantee period.
Annuity payments are based on insurance-industry data for life expectancy, so age and sex factor into the payment amount. The older you are at the time of purchase, the higher the monthly payout. Because women live longer than men, the payout for a woman is lower than for a man of the same age.
A CANNEX Financial Exchanges survey as of March 25 found that the best-paying 10-year guarantee annuity available for $100,000 of registered funds would provide $414 per month to a single 60-year-old woman and $454 to a man of the same age. Waiting until age 75 would increase the monthly payment to $646 for the woman and $748 for a man. As rates change frequently, these payouts are illustrative only.
Annuity payments also depend on the features selected. The cost will be higher for such options as guaranteed payment periods and indexing.
Buying an annuity that increases payments annually at a fixed rate will reduce the impact of inflation on retirement income. With this so-called indexing option, increases of up to 4% are available for registered annuities and up to 6% for non-registered annuities.
However, adding inflation protection is expensive. A mid-March quote from Rino Racanelli of BackToBackAnnuities.com illustrates the impact of indexing. A male, age 65, buying a $100,000 single life registered annuity with no guarantee would receive $527 per month without indexing. With 2% indexing, the income would be just $428 per month.
"It would take about 10.5 years for the indexed income to catch up to the non-indexed income," says Racanelli. "Due to the large difference in income, most clients choose a non-indexed annuity."
Annuity premiums reflect interest rates at the time of purchase. Given current low interest rates, annuities are pricy compared to their historic range. Delaying an annuity purchase for a few years, or buying a series of annuities over time, are strategies for raising annuity income.
No medical is required to buy an annuity unless you have a life-shortening illness and wish to apply for an impaired-life annuity. This type of annuity costs less or pays a higher income than a normal annuity.
Payments from annuities purchased with registered funds are fully taxable as income. The tax treatment of non-registered annuities is more complex. A portion of the payment is return of capital, meaning that it's a return of some of the premium you paid, and is not taxed. The remainder is deemed interest earned on the premium, and is subject to tax.
When it comes time to buy an annuity, look for an insurance company with a superior financial strength rating and a positive financial outlook. You want the firm to be around to make annuity payments for the contracted time period. If the insurance company should fail, Assuris, the not-for-profit organization that protects Canadian insurance policyholders, guarantees annuity payments up to $2,000 per month, or 85% of the promised monthly income benefit, whichever is higher.
Once purchased, annuities are irrevocable, so research before you buy. Seeking the advice of a financial advisor with a broad knowledge of retirement income planning is likely to be money well spent. Annuity rates vary by insurance company, so obtaining quotes from several companies is essential.
As employer-sponsored pension plans continue to disappear in Canada, it is increasingly important for Canadians to fully understand and plan for the financial side of their retirement. Annuities are an option for generating retirement income that should be part of any planning conversation.
