Sep 25 2012

Reduce Stress with a Life Annuity in your Retirement Plan

Reduce Stress with a Life Annuity in your Retirement Plan

Annuities provide consistent regular monthly income payments in retirement.

A life annuity is simply a financial product whereby you invest a lump sum of money with an insurance company and in turn they provide a guaranteed income payment for life. Think of it as buying your own personal pension plan.  Here is an article from the National Post that discusses pros and cons. In think the article’s title ” The best financial product no one really wants” is a bit unfair!  Annuities are often misunderstood by many investors and  not presented by financial advisors as a consideration when designing a sustainable retirement income plan that potentially provides more income than a guaranteed product such as GIC and much less stress than investing in the stock market.

    So why consider a Life Annuity in your retirement plan?

Canadians need to take charge of their retirement accounts well before they actually start retirement! The landscape for company retirement plans is changing fast. There are two types of pension plans, defined benefit (DB) and defined contribution (DC). The trend for employers is to move away from DB plans to DC plans to eliminate their future pension liability. For example, with a DB plan, an employee may be entitled to 60% of their average salary after 30 years service and assuming a $50,000 salary, this would work out to  $30,000 annually for life. The problem is that as market returns for pension plan portfolios have not produced the expected returns over the past decade, many of these plans are under-funded i.e.have insufficient assets to pay retired employees over their expected retirement years. Companies have had to take profits and top-up pension plans which hurt their bottom line, hence they continue to opt for the defined contribution (DC) plan. Following the example above, the DC plan for a company might be to contribute 4% of salary per year, 4% of 50,000 is $2,000 into a retirement plan but that is the limit of their involvement. It is up to the employee to evaluate, monitor and update the investment holdings in their retirement plan throughout their working career and then continue to manage these assets in retirement to generate sufficient retirement income to maintain their lifestyle.  So the bottom line is that employers are shifting the retirement risk for them to the employee. Employees must become more financially literate to manage their retirement assets or work with a qualified financial planner who has the expertise to give good advise!

So when you leave employment for retirement what options do you have for your retirement assets?

What are your options? 

If you are uncomfortable being invested in a market portfolio (cash, stock and bonds) due to the volatility, there are  several options.

  • GICs: Some investors choose to invest in guaranteed investment certificates (GICs), so that they do not lose any of their principal. They rely on the interest paid from the account to fund retirement . In 2012, GIC rates are quite low because interest rates are at a historic low. Five-year GIC rates are in the range of 2.5%.
  • GMWBs: These plans offers a defined minimum payment immediately or in the future depending upon when you decide to begin the income stream. Click here to read more about GMWBs…

So why consider a Life Annuity in your retirement plan?

If you like guaranteed income, then the annuity may be of interest. As mentioned at the beginning of this article, the annuity is simply buying a pension plan with retirement assets. Specifically the investor (called the annuitant) takes a lump sum of money or transfers from their DPSP, RRSP, RRIF, LIRA or LIF in exchange for an income stream (typically monthly) which is guaranteed for their life.

How much (what return) does a Life Annuity pay?

The annuity payment is based on several factors such as your age, whether you are male or female, and what options you want for your plan. Some typical options are joint and last survivor (for couples the income continues after the first person passes away until the second person’s death), inflation protection, guarantee payment for a number of years and many others. These options are beyond the scope of this article but basically the more benefit options, the lower the initial annuity payment.  Therefore the annuity payment is specific to you and your personal situation. Use a qualified life insurance agent to provide quotes for the numerous life insurance companies in Canada to obtain the most suitable solution.

What if the insurance company fails?

In the unlikely event that a life insurance company that you originally purchased the annuity from were to go bankrupt your payments are guaranteed by Assuris. This not for profit organization protects Canadian policyholders of annuities up to $2,000 per month or 85% of the promised Monthly Income benefit, whichever is higher.

What else should I understand about Life Annuities?

Annuities are a one-time purchase. By that I mean, once the annuity is set-up, it cannot be changed or undone and you can’t cash it in. One option to understand is the “guaranteed period” which specifies the minimum number of years the annuity will be paid, especially if you die before that period ends. For example, if you specify a 10 year guarantee period, and you die after five years, your beneficiary receives the remaining five years of payments.  A qualified agent should go over these options in detail to ensure you understand the implications and how it affects the annuity payment you receive.

How much should I consider investing in a Life Annuity?

I recommend that you do a retirement analysis and review your needs with a qualified professional.  As an independent life insurance broker and Certified Financial Planner, I do both retirement income planning as well as offer annuities from all the major insurance companies in Canada.

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