When To Consider An Annuity
An annuity is in essence a contract between you and a financial institution, usually an insurance company, under which you give The institution an amount of money in return for a promise to provide you with a fixed income for a defined period of time, often in monthly payments. Annuities come in a wide variety of types, and are irrevocable. You can buy an annuity at any age.
Annuity income that originates from an RRSP is fully taxable in The year received. The amount of The payment is determined by various factors, The most important being interest rates at The time of purchase. Others include your life expectancy, your age, your gender (women get paid less in general because they live longer on average), and The amount you invest. Options such as guaranteed terms or indexing against inflation cost more, in that your payments will be lower.
Although a RRIF can be your most valuable source of retirement income, everything has its price, and along with The flexibility, The control, and The estate benefits of RRIFs come certain risks. These include low interest rates (particularly if your RRIF investments are primarily interest-bearing securities), unfavourable market conditio, poor investment choices, unsatisfactory income planning, and lump-sum withdrawals.
With control comes responsibility, and poor investment decisions or taking out too much money too soon could have a major negative impact on your income and capital.
Your RRIF investment choices have an important effect on your decision as well. If, for example, interest-bearing securities (GICs, term deposits, bonds) were your investments of choice in The 1980s, it made sense to choose a RRIF and to delay The purchase of an annuity. The lower minimum payout schedule in effect at that time (The rules were changed to increase minimum payout requirements in 1993), combined with The higher interest rates then available, allowed RRIF capital to grow, even as income was paid out every year. In The 1990s and into The new millennium, however, interest rates are substantially lower, often providing less income than The new requirements for higher minimum payouts. This means that RRIF capital (again, depending on your investment choices) could start to shrink immediately. The combination of longer life expectancy, earlier retirement, and lower interest rates leads to The risk that investors may outlive their capital.
For example, before 1993, The minimum withdrawal required of a 71-year-old was 5.26 percent of The assets in a RRIF, a sum easily covered by The interest rates being paid at that time. Now, however, that minimum has been increased to 7.38 percent, which means that The value of your plan will begin to decrease after you reach 71 unless your RRIF investments earn more than that.
Therefore, if conservative investments, security, and maximum income for life sum up your key objectives, you should take a serious look at annuities. On The other hand, if you have sizeable RRSP and non-registered assets, and your investment knowledge and approach can tolerate even The most moderate of risk, a RRIF is a much better fit. It will allow you to further grow your capital and maintain flexibility for estate and other planning purposes.
An important part of RRIF flexibility is that, unlike an annuity, you don’t have to keep it forever. At some point, even with The balanced, diversified investment portfolio we recommend, The payments from your RRIF will begin to decline. Exactly when that will happen depends on several factors, including The amount of money you take out each year and The growth rate of The assets in The plan. Typically, however, The decline in payments will happen sometime in your 80s. Before it does, it may make sense to use some or all The money in The RRIF to buy a life annuity. Because of your advanced age, The annuity payments will be much higher. And they will be locked in for life, so you will not have to worry about The cash ever running out.
Some people prefer annuities because they are simple, predictable, and secure. Once you buy an annuity, no further money management is required on your part. You do not have to worry about GICs, bonds, stocks, or mutual funds. Nor do you have to be concerned about where The market or interest rates are going. Dramatic downward spirals in The economy will not affect your annuity nest egg. You receive a guaranteed income either for life, which ensures that you will not outlive your capital, or for a specific term, and The payments can be issued for The extent of your life alone, or can be directed to be paid to your spouse, should you die first.
You should consider an annuity if any of The following is true for you:
- You feel uncomfortable with The thought of making your own investment decisions, or you don’t have the time;
- You are unable to find someone you trust to make these decisions for you;
- You feel you absolutely need a guaranteed monthly income to cover your basic needs;
- You believe that cost-of-living increases will have little impact on The expenses you will need to pay;
- You are in good health and your family has a history of long life expectancy;
- You have no dependents or heirs;
Adapted from Gordon Pape’s 2000 Buyer’s Guide to RRIFs and LIFs by David Tafler and Gordon Pape, published by Prentice Hall Canada