Back-to-back annuities make a comeback

Annuities, those age-old stalwarts of longevity planning, have been popping up on the investment radar with some gusto recently, propelled by recent financial terrors and a renewed interest in consistent, reliable gains versus flash-in-the-pan returns that often quickly evaporate.

Andrew McCully, vice-president at MGI Financial, says that while low interest rates hamper the attractiveness of standard annuities, the overall investment climate encourages clients to take a second look at annuities.

“Many went into annuities out of fear—people are concerned about their money disappearing. If your portfolio shrunk from $100K to $70K and now is back to $90K, that makes you start thinking about preserving that remaining money. Lots of people may be more comfortable with annuities today than five years ago,” he said.

The best option in today’s market, according to McCully, is a back-to-back annuity which combines a life-only annuity with a guaranteed life insurance policy to preserve and pass down capital in the event the client dies earlier than expected. Essentially, the client buys an insurance policy in the same value as the annuity to create a win-win situation: if the client dies early, the life insurance will pay out to beneficiaries, counter-acting the early loss of remaining capital in the annuity; if the client lives longer, the annuity keeps paying out income at a consistent return.

John Novachis, president of IPC Investment Corp. and IPC Securities, says he hasn’t seen a huge spike in annuity sales overall, but sales of back-to-back annuities appear to be gaining steam because the overall returns can be consistently better than GIC solutions.

“When you use open money to purchase an annuity and some sort of life insurance to back it, the after-tax effect of that is more favourable than investing in a GIC. Plus it preserves the capital if you want to pass it on to your beneficiaries,” he says.

Still, Novachis says it’s important to see the forest as well as the trees, in that the overall financial climate is not exactly in a sweet spot for annuities. With interest rates dredging the the bottom of the barrel, returns are much lower than they used to be and the lengthening average lifespan among clients is not going unnoticed by annuity providers.

“People are living longer and that has an adverse effect in terms of the payment. In low interest rate environments right now, an annuity is not for everybody,” Novachis says.

Good back-to-back annuities work best with larger sums for clients generally in the highest marginal tax bracket and they only work well as long as interest rates stay low. When considered alongside the complete loss of liquidity in the money by locking into a back-to-back annuity, Novachis says the option might only make sense for the most risk-averse, resource-rich clients who are no longer interested in exerting influence over their money—a potentially niche group.

“We’re creatures of habit, we spent so many years saving this money and to give up control of it is not an easy thing to do,” Novachis says.

McCully offers the example of one of his own clients to illustrate the current weakness of standard annuities not backed by life insurance. The client, a woman now aged 91, bought a standard annuity with a 10-year guarantee in 1995, when she was 74 and the Bank of Canada interest rate was hovering around 7.5%. She put down $70,000, and based on her market factors received a monthly income of $694.80. To date, her annuity has paid her more than $130,000.

If that 74-year-old woman were to purchase the same $70,000 annuity with a 10-year guarantee under today’s market conditions, the monthly income would be only $476.52 and she would earn about $43,000 less over the same period.

However, compared to a longevity vehicle like reverse mortgages, which have been getting a lot of press recently, annuities are far superior, Novachis says. The tax efficiencies inherent to annuities—a large chunk of an annuity’s monthly income payment is deemed to be return of capital for tax purposes—make annuities a credible option despite low interest rates.

“It’s an option to consider—continued saving and investing is another option. There are cases where you might see an annuity being more favourable,” Novachis says.

Raf Brusilow is a Toronto-based financial writer.