Hot topics: Relevance and future of retirement annuities

There are no guarantees with most financial products—but that’s not the case with annuities. Here’s a product that provides stable, secure income for life, eliminating the risk of outliving your money. Yet, in a low interest rate environment, many investors have steered clear of them. We asked two advisors to give us their take on the following resolution: that a turn in interest rates will change the picture for retirement annuities, and that this will happen soon.

Lise Andreana, CFP, CPCA Wealth and Estate Planner Continuum II Inc.

Even with low interest rates, if you’re a retiree who doesn’t have a defined benefit pension plan and your government pensions are not covering all of your fixed costs, life annuities are very good for filling that gap. Because life annuity payouts are based not solely on interest rates—they include a mortality factor—they work best for the elderly. A life annuity gives retirees the security of an income that a bond portfolio or GIC portfolio cannot. It’s absolutely guaranteed. You never have to think about it again. And, in the growing absence of defined benefit pension plans, I believe annuities are going to play a bigger and bigger role.

One consideration is longevity in the client’s family. That’s critical because I’m selling my money in return for a lifetime of income and the life underwriters tell us this generation is likely to live seven years longer than the generation before. I have to have that conversation with my clients so that they can better understand the length of time they’re going to need income for. If you’re like the 19th century literary Brontë family, who all died in their 50s, annuities don’t play a very big role in that kind of scenario!

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I’m not an economist, but my sense is that over time interest rates are going to rise, and that’s part of the danger when we’re making an annuity recommendation to a client with great longevity—because if interest rates go up, inflation is going up, so they’re going to be exposed to inflation. Variable annuities (versus traditional annuities) play a role where I want to leave something behind for the estate, where I’m nervous about inflation and where my client doesn’t like risk.

Most important, I don’t see any retirement income plan as a single ticket purchase on the part of the client. There’s often a place for all different kinds of products based on individual needs. That’s why it’s so important for investors to work with a Certified Financial Planner who can assess goals, income, and expenses and prepare a plan that’s structured specifically for a client’s circumstances. There’s no one-size-fits-all solution. Every client’s plan is completely different from everybody else’s.

Clay Gillespie, BBA, CFP, CIM Financial Advisor & Portfolio Manager Managing Director Rogers Group Financial

Everybody thinks annuities are strictly an interest rate vehicle, which is not always true. The later you buy an annuity, the less the payment is calculated based on interest rates and the more it’s calculated based on mortality credits. We believe it’s mathematically better to transfer registered funds into a life annuity around 77 years of age. At that point, the interest rate is not really relevant and the beauty of pooling risk inside a life annuity is enhanced. Because what are clients worried about? They’re worried about running out of money and that’s what an annuity doesn’t allow you to do.

I don’t use annuities as much for non-registered money, but they can be very useful because of the prescribed tax treatment allowed by the Income Tax Act. Typically, if you had a bunch of GICs and you were digging into the capital, you would pay high tax in the early years and low tax in the later years. With an annuity’s prescribed tax treatment, you pay a lot less tax in the early years. You may pay more tax later, but the tax deferral is valuable.

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Another strategy: if a couple is age 70, they can buy a single life annuity that dies with one individual and life insurance that replaces the capital for the other individual. So, for example, a $100,000 no-guarantee annuity and a $100,000 life insurance policy. They get a much higher payment from the annuity because there’s no guarantee period on it and they get the prescribed tax treatment. It’s working out now to about a 5.5% to 6% rate of return after tax.

If interest rates rise, that would simply bring forward the age where it may make sense to annuitize registered money and make annuities a little more attractive for non-registered money. But I think annuities are really attractive now. I’ve never understood the whole defined benefit/defined contribution pension “problem.” When you retire, you can buy a defined benefit pension plan all by yourself. That’s all a life annuity is: a pension. I call it the Rodney Dangerfield of investments—it’s truly misunderstood. But it can solve a lot of problems.