Retired investors face a challenging set of financial and investing risks. Several are not faced by those in the accumulation stage of life and are unique to the retirement withdrawal phase. Traditional portfolios of equities and fixed income, such as systematic withdrawal plans like the 4% rule (see posts here and here), can succeed in the face of such challenges. But they can do so more easily if combined with guaranteed lifetime income sources such as defined benefit pension plans, Canada Pension Plan (& OAS) and lifetime annuities.
Complementary Roles - Systematic Withdrawal Plan vs Lifetime Guaranteed Income
The table below shows how the two categories of income sources complement each other very well. Against most of the risks and the beneficial features, where one falls short with a NO, the other copes well with a YES. Only for inflation and tax minimization does neither type provide an ideal mechanism.
(click on image to enlarge)
Annuities fill a gap for retirees without a DB pension
Most retirees will get CPP and OAS but they max out at $12,780 and $6,765 (2015 figures) respectively, which probably is not enough to meet basic living expenses. Since fewer and fewer Canadians have defined benefit pensions and are saving in RRSPs, TFSAs or defined contribution retirement savings plans, all of which consist of equity-fixed income portfolios, the annuity can fill a significant gap.
One of the worst dangers of retirement, when money is being taken out of a investment portfolio for living expenses, is that withdrawals may be too high and the portfolio expires before the retiree, leaving the unfortunate person high and dry, usually at an advanced age when going back to work to make a shortfall is no longer possible.
An annuity is an investment income insurance product in which an investor hands over a lump sum to an insurance company and then receives a fixed, guaranteed, regular (monthly, quarterly, semi-annually or annually) income for life. In the plain vanilla version, the income continues only as long as the person lives (or the second of a couple to die, in the case of a joint annuity) and there is no return of principal at death.
Since many people balk at the idea of losing the whole principal if they live only a short time after the annuity starts paying - imagine handing over $100,000 of your lifetime savings to the insurance company and living only long enough to receive the first monthly cheque of $530 or so (per the Globe and Mail's table for single life 65 year old male as of June 10, 2015). Being dead you wouldn't be upset, but your heirs might be! The annuity purchase is irreversible. Consequently, insurance companies offer options to guarantee payments to the estate or a beneficiary for 5, 10 or even 20 years. Such guarantee options do come with the downside of lower payments.
Contrary to what some may imagine, the insurance company does not keep all the money of investors who buy a plain no-payout-guarantee annuity and then die early. The insurance company does keep some of the money of those who die early for its costs and profit margins, but this is kept in check by the fact that the annuity market is competitive amongst insurance companies. Given the guarantee of income provided by Assuris in Canada, most investors can safely opt for the best quote aka highest income so the companies are unable to profiteer. Instead, the bonus money, called mortality or insurance credits, goes to other investors who live a long time. The insurance company is able to calculate very accurately the average remaining lifespan for a population of retirees (and even that of retirees who buy annuities, which happens to be longer than retirees as a whole), which enable it to price out a payment level for everyone based on the average and to offer it for as long as you might happen to live. Live long like Merle Barwis, you win!
Research shows the annuity - SWP combination enhances retirement success > more income and less chance of running out
Economists are constantly puzzled by the relatively low rate of uptake of annuities because they are beneficial to retiree investors. Researcher Wade Pfau, Professor of Retirement Income at the American College of Financial Services on his blog has posted papers detailing the benefits of immediate and deferred annuities. Professor Mark Warshawsky of George Mason University compared life annuities head-to-head with the classic 4% portfolio withdrawal rule using US historical data in Government Policy on Distribution Methods for Assets in Individual Accounts for Retirees and found that annuities generally performed somewhat better for providing lifetime income during retirement. Canadian Associate Professor of Finance at York University Moshe Milevsky explains annuities in detail in the free 150 page Life Annuities: An Optimal Product for Retirement Income. He and co-author Alexandra Macqueen put forth a popularized exhortation to include annuities within a retirement income mix in the book Pensionize Your Nest Egg. David Blanchett, Head of Retirement Research at Morningstar in his Allocating to a Deferred Income Annuity in a Defined Contribution Plan even cites a source that found that investors with annuitized incomes were happiest! If money can't buy happiness, can it buy an annuity which can buy happiness?
Where to buy: Annuities are only available from insurance companies, so interested investors need to contact either a life insurance agent, who represents only one company, or better, a licensed broker who can source quotes from the whole market and get the best currently-available deal, which varies constantly amongst the various insurance companies. Specialized annuity brokers in Canada with an online presence are sparse - two we found (whose licensing claims check out as of June 2015) are LifeAnnuities.com (Ivon Hughes) and Canadian Annuity Broker Services (John Beaton).
Buying an annuity involves handing over a big chunk of money, so check that the agent or broker is licensed in your province:
- Financial Services Commission of Ontario
- Autorité des marchés financiers (Québec)
- Alberta Insurance Council
- Nova Scotia Superintendent of Insurance
- Insurance Council of British Columbia
- Insurance Councils of Saskatchewan
- Insurance Council of Manitoba
- Financial and Consumer Services Commission of New Brunswick
- Government of Prince Edward Island
- Newfoundland and Labrador
- Government of Nunavut
- Yukon Government
Disclaimer: This post is my opinion only and should not be construed as investment advice. Readers should be aware that the above comparisons are not an investment recommendation. They rest on other sources, whose accuracy is not guaranteed and the article may not interpret such results correctly. Do your homework before making any decisions and consider consulting a professional advisor.
Copyright 2015 Jean Lespérance All Rights Reserved
0 komentar:
Posting Komentar