The reason why retirement planning is so difficult is because the one variable we need to know – how long we have to live – is impossible to predict. Sure, we have mortality tables and family history to help guide us, but statistically speaking, half the population will outlive their median life expectancy.
That makes longevity risk – the risk of running out of money before you die – a very real threat to your retirement. And yet many Canadians ignore this threat by not saving enough during their working years; retiring before they’re financially ready, taking Canada Pension Plan benefits too early, withdrawing too much from their RRSPs, and so on.
Nearly half of Canadians are worried they won’t have enough money to live a full lifestyle in retirement, according to a recent survey by RBC Insurance. They interviewed 1,000 Canadians aged 55 to 75 about their retirement readiness and came out with some interesting findings.
The retirees, or soon-to-be-retirees seem to want it all, according to the poll, yet many will lack the savings to do so:
- 80 per cent want to live at home for as long as they can
- 72 per cent said it’s important to own a car.
- 68 per cent said it’s important for them to be able to travel at least once a year
- 53 per cent want to go out for lunch or dinner a few times a week
Having enough money to support their desired lifestyle is a real concern, highlighted by the fact that 62 per cent of those surveyed are worried about outliving their retirement savings.
The one retirement income tool that didn’t appear on the radar was an annuity. Just 12 per cent said they are using or plan to use one in retirement.
How Annuities Can Help In Retirement
An annuity provides a predictable income stream for life – much like how a defined benefit pension, CPP, and OAS pays benefits for as long as you live. Nothing protects you from longevity risk quite like a guaranteed lifetime income.
It’s puzzling why more Canadians don’t choose to turn even a portion of their savings into an annuity – to pensionize their nest egg, to borrow a phrase coined by financial authors Moshe Milevsky and Alexandra Macqueen.
Lack of knowledge around annuities definitely plays a role. While nine in 10 Canadians polled by RBC know they don’t need to invest their entire retirement savings into an annuity, just 28 per cent know that an annuity doesn’t have to be managed once it has been purchased.
Some other tips you might not have realized about annuities:
- It’s possible to invest in an annuity using your RRSP and/or RRIF savings.
- An annuity provides a predictable income stream for as long as you live, regardless of whether financial markets rise or fall.
- You can stagger your annuity purchases to help increase payouts.
Annuity Payout Rates
Speaking of payouts, I thought it would be helpful to see some examples of just how much income to expect from an annuity based on several different scenarios:
| Deposit | ||||
| Age | Gender | $100,000.00 | $250,000.00 | $500,000.00 |
| 65 | F | $ 5,354.53 | $ 14,106.01 | $ 27,939.89 |
| M | $ 5,902.14 | $ 15,458.49 | $ 30,339.23 | |
| 70 | F | $ 6,149.82 | $ 16,069.36 | $ 31,426.43 |
| M | $ 6,795.94 | $ 17,669.89 | $ 34,346.74 |
*Assumptions
-Single Life annuities
-Rates as of Jan 11, 2018
-Registered funds
-10 year guarantee period
-1 month deferral period (i.e. time between depositing the money, and receiving their first payment)
-Annual payment frequency
I’ll be honest; I perked up when I saw the payout rates were between 5 and 7 per cent of the initial deposit. Now, keep in mind, those rates won’t increase with inflation each year, but it’s still a healthy (and guaranteed) amount to receive for life.
I mean, why wouldn’t a relatively healthy 70-year-old male not want to turn $250,000 into annual income of $17,669.89?
If he reached his median life expectancy of 84 years he would have collected $247,378.46 in annuity payments. Call it a break-even. But what happens if he lives until age 90 or 95? Now he’s come out ahead by $100,000 or $200,000.
Remember, we’re talking about protection against longevity risk. As tragic as it would be to get hit by a bus in the year you purchased an annuity, you won’t be around to curse the decision and, if you get a 10-year guarantee period, you’ve built in some protection for your beneficiaries.
Under-spending in Retirement
One last thing on the annuity puzzle. Some proponents argue that annuities not only protect against longevity risk, but also the risk of under-spending in retirement.
A U.S. study found that roughly two-thirds of retirees who have $150,000 in savings at age 65 tend to spend no more than they receive from guaranteed income sources, such as Social Security and pensions. They’re afraid to spend the lump sum because they value liquidity.
An annuity, being a guaranteed income source, would make it possible to spend a bit more freely in the early years of retirement.
Final thoughts
Annuities can play a vital role in your retirement planning by helping to mitigate the threat of outliving your money while providing a predictable income stream for life.
I’m not suggesting you turn every penny of your million-dollar portfolio into an annuity, but carving out a portion to create your own personal pension will add another valuable income stream that you never have to worry about managing in retirement.
In addition to running the Boomer & Echo website, Robb Engen is a fee-only financial planner. This article originally ran on his site on Jan. 23rd and is republished here with his permission.
Great article! For those of us without defined benefit pensions the reliable income stream of an annuity seems attractive and they don’t get enough attention IMO