Annuities | General financial discussion | Discussion forum

It's true that they're out of favour at the moment, primarily, I think, because interest rates are so low.

They do make a certain amount of sense, depending on your circumstances and age. There was at least one other thread about this earlier which you may want to look at.

It's possible to buy an annuity that is guaranteed for X years, usually 10. If you die before that time is up, it will pay out the remainder to your estate. I think you can also buy them with a life insurance payout but I am not sure about that - and they would definitely cost more.

The question arises as to why you would care if it doesn't pay out after your death since it won't affect you. If you do care, it implies that you are trying to leave an inheritance. Annuities are not a good tool for that - except for charitable annuities, which are a whole other field. They are an income tool for while you're alive.

Its possible to buy an annuity that covers both spouses so that it carries on until the survivor dies, much like an RIF. The RIF, however, may leave a remainder to your estate although it will be fully taxed upon death of the survivor.

What they are good for is as a portion of your retirement income. Let's say you want to have a minimum income of 60K in retirement. You have OAS, CPP and perhaps a corporate pension, some savings and some RIF/LIF funds. You need to find a way to draw enough money from them on a steady basis so that you always have the 60K and also, hopefully, allow for inflation. The portions that are guaranteed and linked to inflation are probably the OAS and CPP, maybe pension plan if you have one (although those are not all linked 100% to inflation). Let's say you have 45K from OAS, CPP and pension plan; that means you have to find the other 15K. For the rest, you are dependent on income from savings, RIF etc., which will fluctuate from year to year., depending on your returns from investments. If you use some of your savings to buy an annuity, then you may be able to get your guaranteed 60K without having to worry about these fluctuations or how you are going to draw the money. Then you are free to invest whatever other money you still have in whatever way you want, and to consider your heirs, without worrying that there won't be enough for you on an annual basis.

That said, I believe the previous discussion concluded that it was difficult or impossible to get an annuity in Canada that would be adjusted to inflation; and, if you did find one, the return would be significantly lower. The way to cope with that, such as it is, is to buy more than one annuity and spread the purchases over time. Some suggest buying them gradually between ages 70 and 75 approximately; others suggest waiting to about 80. The longer you wait, the higher annual return you will get, but of course for a shorter time. On the other hand, you may benefit from rising interest rates, if they ever come. You may also be able to deal with inflation by selling a property at some point, thus freeing up more capital.

Another reason some people like them is that they can help to cope with the mandatory RIF withdrawals. Some people find that the rates the government has set do not fit with their own needs, and prefer a consistent predictable amount which will in due course be lower than the required minimum withdrawal. If you expect to live into your late 80s or 90s, it can also be a way of avoiding coming close to the 20% range of mandatory withdrawals, which can bump up the tax bite in your later years. Also, this high withdrawal rate comes at a time when you are not likely to be doing a lot of discretionary spending. The actuaries say we do most of our spending as seniors by age 75, although this too may creep up, if you live long enough to enjoy it.

One other thing that can be helpful in terms of taxes is if you buy the annuity with your non-registered funds. Because a good chunk of the annuity payments are from the capital which you contributed, that chunk is not taxed if it's not in RIF when it is returned to you as annuity income. This enables you to spread out your operating funds while still keeping your taxes and clawbacks under control. You could, alternatively, just take the money out of your savings. But the annuity frees you from having to manage the money and ensures a steady predictable flow which will never run out. While it may not protect you adequately from inflation, it does protect you from market downturns and the bad decisions that people sometimes make when they are no longer as mentally sharp as they once were.

And this brings me to one other advantage. If you have no one to whom you need or want to leave your money, if you don't have anyone who seems like the ideal person to hold your power of attorney, if you are or will be alone in your old age, if you are afraid of losing your wits and losing control, an annuity may be part of the answer. It will just keep paying out and you don't have to lift a finger to manage it. It takes the worry out of investing, especially if you feel you ought to be in the stock market but realize your time horizon isn't suitable.

I think the main use of annuities should be to top up your income to a desired level, to provide a secure basic income. People with substantial assets don't need them; and people with minimal assets don't have the money to put into them. People with relatively small assets but not broke should probably just cash out any RSPs over a few years so as not to have that drain on their taxes and clawbacks etc. later, and put any excess into TFSAs.

If you decide to buy one, go to an annuity broker. They are too complicated and too variable to just deal with one institution. Rates change constantly, but, once you lock in, that's it.

Loonie said

That said, I believe the previous discussion concluded that it was difficult or impossible to get an annuity in Canada that would be adjusted to inflation; and, if you did find one, the return would be significantly lower.…

That previous discussion was Indexed annuities. That was spawned by these two posts.

AltaRed, I agree. Let's say that your last surviving parent has a small but real chance of outliving her money, let's say that you are the one loyal offspring to stick around in her old age to visit or help so she has entrusted you with her finances, let's say you decide to blow the last few hundred thousand for a generous annuity that goes until her death, let's say that relieves Mom's money worries forever. (Let's say another bonus is that the other offspring, the uninvolved ones licking their lips in anticipation of their small but still eagerly-awaited inheritance, are really mad now and - thank you! - cut off all communications with you and leave you forever in peace.) Hypothetically. Just one example where an annuity can accomplish a lot.

Offloading longevity risk and the non-cash benefits Bill mentioned seem to be all life annuities offer at the moment.

The current annuity returns are quite underwhelming. I ran some rate of return numbers using the best rate from the Globe & Mail life annuity rates for Mom starting age 65, 70, and 75.

Returns, the financial ones (not including what Bill mentioned), don't look very appealing unless she makes into her 90's. Also, with the current prices, it is not always better to start later at 75 than at 65:

You'll get a better return if you forego the 10 year guarantee which, after all, is really only for the beneficiaries.
To see any benefit, one needs to look at it as part of a retirement income system and largely forget about beneficiaries. Longevity is a consideration in that, but longevity is less predictable than income needs.

My favourite related story, not exactly parallel, as it is about life insurance, but bears many of the same considerations, was about a woman in France who died perhaps 10 years ago or more. It was prominent in the news at the time. Someone had bought a life insurance policy on her when she was perhaps in her sixties; I don't remember precisely. He thought it was a no-brainer. Time passed. The guy who bought the policy died. Time passed. The old lady got older and older and lived to be the oldest person in the world. She was in her 120s when she died, as I recall.

Loonie said
…
My favourite related story, not exactly parallel, as it is about life insurance, but bears many of the same considerations, was about a woman in France who died perhaps 10 years ago or more. … She was in her 120s when she died, as I recall.  

I found someone of that description: Jeanne Calment. If it was her, then the parallel is quite good as it was about a life annuity!

Apparently, a then 47-year-old lawyer agree to pay the then 90-year-old Calment a life annuity in return for her apartment. This is from the Wikipedia article about her:

… In 1965, at age 90 and with no heirs, Calment signed a deal to sell her apartment to lawyer André-François Raffray, on a contingency contract. Raffray, then aged 47 years, agreed to pay her a monthly sum of 2,500 francs (€381.12) until she died. Raffray ended up paying Calment the equivalent of more than €140,000 which was more than double the apartment's value. After Raffray's death from cancer at the age of 77, in 1995, his family continued the payments until Calment's death. Calment's comment on this situation was reported to be, "In life, one sometimes makes bad deals." …

I doubt it.

Current Canadian prime lending rate is 3.95%. A creditworthy insurance company can borrow from their bank for that rather than pay 5% (plus commissions to the selling agent) through a life annuity bundled with a life insurance policy.

At age 65, a male could have purchased a no-guaranteed-minimum life annuity in February from BMO Insurance of $543.05/month for $100,000. That's $6,516.60 per year for a payout rate of 6.516%.

A permanent $100,000 Term 100 life insurance policy from BMO Insurance for the non-smoking male costs around $3,400 per year or 3.4% per year. That's assuming BMO Insurance will agree to life insure the male.

The net is only 3.1% each year. On death, there would be $0 from the life annuity and $100,000 from the life insurance policy.

If the male were a smoker, the life insurance jumps to about $5,000 per year and the net would only be 1.5% per year.