A burgeoning cohort of baby boomers concerned about bumpy financial markets is turning increasingly to annuities as part of its retirement planning. Many are seeking the peace of mind that comes with a steady, guaranteed income stream for life.
There are also other realities driving annuities’ rising popularity. The golden age of defined-benefit (DB) pension plans is receding, making the fixed monthly payments of an annuity a bigger draw. According to Kari Holdsworth, vice president, individual wealth, at Toronto-based Sun Life Financial Inc., annuities are like a personal DB plan, giving clients a fixed benefit for life.
“Another reason [for the growth in annuities],” says Holdsworth, “is that with interest rates being low today and the markets having gone through some turmoil, there is a great awareness among those retiring that their future income is exposed to risk.”
Annuities, which don’t require a medical before purchasing, also take advantage of “mortality pooling,” which uses averages of life expectancies in a particular age group to set the payout rates for annuities. An example from Sun Life uses annualized income from a $100,000 annuity as of Oct. 1, 2012: a couple that purchases a joint annuity at age 65 will receive $5,170 a year (paid out monthly); of 10 couples aged 65, nine are expected to have at least one spouse surviving at age 85, by which time they will have received slightly more than the original $100,000 in income.
Generally, financial advisors agree that only a portion of a client’s retirement income should come from annuities. How much depends on the individual’s needs, risk tolerance and whether he or she wants to leave a financial legacy. For this decision, the cost of essentials like housing, food and transportation is key.
“Annuities are usually put into a retirement plan to cover the basics, the essentials, the things that won’t go away,” says Josephine Gurreri, associate vice president at Montreal-based Standard Life Assurance Co. of Canada. “For that guaranteed stream, you would want to lock that in with a life annuity. The rest of your retirement savings you can use for discretionary purposes.”
There are online tools to help you establish how much a client should put into an annuity to meet his or her fixed monthly expenses. Winnie Go, senior wealth advisor with Toronto-based ScotiaMcLeod Inc., recommends that 10%-20% of total investible assets go into annuities.
Once your client has decided on annuities, he or she can choose from a variety of bells and whistles. For example, there are joint-and-survivor annuities that provide reduced payments to the surviving spouse, says Gurreri: “Sometimes, if you want to make the annuity less expensive, you can say that after the first death, we might not need the same amount of income.”
There are also annuities with fixed terms. These offer a long guarantee period in exchange for lower monthly income. Or, Holdsworth says, a shorter guarantee period with higher income is available.
Some annuities have a set guarantee period with any remaining amount in the period going to beneficiaries if the annuity-holder dies before the period is over. “You can select whatever guarantee you want,” says Gurreri. “But, of course, the more the guarantee, the more expensive the annuity will be.”
Go prefers using non-registered money in prescribed annuity contracts, which are taxed in a more efficient manner than is interest income. For a prescribed annuity, a portion of each payment is taxable and a portion is a return of capital, which is not taxed.
But not all clients are suited to annuities. The biggest drawback is that the capital used to purchase the annuity essentially is lost. (For other drawbacks, see sidebar below.) IE
Top five drawbacks of annuities
1. Annuities are not liquid; they cannot be cashed out.
2. Decisions on the annuity plan must be made at the time of purchase and cannot be altered if needs change.
3. Increases for inflation are not available unless the annuity has that specific protection – usually for an additional cost.
4. If interest rates are low at the time of purchase, that rate is locked in for life (or the term of the contract).
5. Unless the annuity contract specifically states otherwise, beneficiaries do not receive anything.
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