Annuity Update - September 2020
2020 has been quite a roller coaster for investors so far, to say the least. COVID-19 was the primary reason for the market's decline in March 2020 and thankfully the outlook is slowly improving. While younger investors may take advantage of low prices for securities due to a longer term time horizon, those in the retirement risk zone (within 10 years of retirement) and further into retirement, don't have that luxury. There are other shifts that I am noticing as a financial planner.
Companies Transitioning from DB to DC Pension Plans
What I have noticed over my 20 year career as a financial planner, is that companies continue to shift away from defined benefit pension plans (DB plans) to defined contribution plans (DC). A DB plan is a pension plan based upon your salary and years of service and the resultant pension is guaranteed for life. The newer companies are offering the DC plan in which the employer makes contributions to the retirement plan but you, the individual, assume the risk now to generate a return and once you leave the workforce, you have to manage that investment and it's income generation for life. What results is that many persons transfer their large DC plans out of the company at retirement and convert to a LIF (locked in fund) when they need to start withdrawals. There is nothing wrong with that in and of itself. But what I also see is retirees with guaranteed income sources of only the CPP and OAS which represents a relatively small part of their required expenses. The LIF accounts, in turn need to provide sustainable income month in and month out and depending upon volatility, can be stressful for many investors as they age.
"Comfort Ratio" Declining
I define the "comfort ratio" as the percentage of income coming from guaranteed income sources such as CPP, OAS and company pensions as a percentage of total annual expenses in retirement. In the past, these guaranteed sources where the substantial payout vehicles representing close to 100% of the income in retirement. Below is the formula for the comfort ratio.
Now, it's not uncommon to have only CPP and OAS as the guaranteed income sources and a large RRSP (or LIRA) that is converted to a RRIF (or LIF) when regular income is needed in retirement. Depending upon your income needs, your true risk profile can be put to the test, if and when markets correct and take time to recover. In this situation, your "comfort ratio" may only represent 50-65% of the total annual expenses.
There is no right or wrong answer of how much of your cash flow you want guaranteed, however, I would sum up your "essential" living expenses and see how that compares. Would you be comfortable if, at a minimum, your essential expenses are covered? Only you know the answer to that question.
Investors Often Overlook Annuities for a Portion of Their Retirement Income Solution
If you aren't comfortable with withdrawals from large registered accounts, that's where "life annuities" may play a role. "Life annuities" are a product you buy to produce a lifelong income that is unaffected by market performance. This is often referred to as "longevity insurance", since you can't outlive your money.
I have begun to periodically publish a baseline annuity update using a single scenario which are the default settings of the Cannex software. The CANNEX Financial Network enables financial institutions to automate the application processing and administration of bank and annuity products in Canada. These default settings are for a 65 year old single male whose birthday is today, has $100,000 in an RRSP, wants to buy a life annuity today and begin payments one month from today. He has a guaranteed period of 10 years, meaning if he passes away before the end of the 10th year, his beneficiary would receive the remaining payments as a commuted value. So for September 1, 2020, the baseline scenario first data point is a payout of $5,721.84 annually ($476.82 monthly) for a $100,000 investment as shown in the Income Annuity Survey below. This is a payout of about 5.7% of the capital invested ($5,721.84 / $100,000). I redacted the insurance company names as there is no one insurance company with consistently the highest payout.
The major life annuity providers in Canada are as follows.
- BMO Insurance
- Canada Life
- Desjardins Financial Security
- Empire Life
- Equitable Life
- RBC Life Insurance Company
- Sun Life Assurance Company of Canada
Once your annuity is designed ( all options chosen), until you actually make the purchase decision, the annuity payment can fluctuate slightly depending whether interest rates are moving up or down. Also since you get one day older every day, and as annuities are based on mortality data, it has an effect, albeit small.
Life annuities cannot be purchased directly online, they must be purchased by a life licensed insurance agent. I also have put in place a process whereby we don't need to meet one-on-one, so I can service all eligible residents in Ontario, Canada. If you would like an estimate of what an annuity might pay in your situation, please contact me and I'll email you the details required to provide an Income Annuity Survey. To learn more about annuities, enter your first name and email in the green box on this page. You'll receive a series of short emails with more tips, information and education.