This guest post was written by Brian Poncelet is an insurance specialist and independent certified financial planner (CFP) working in the financial services.
How annuities can help you fight Groundhog Day
Have you ever seen the movie Groundhog Day? It’s a comedy starring Bill Murray and Andie MacDowell where a Pittsburgh weatherman is forced to live the same day over and over again, until he finally figures out what he needs to do to set the day right. These days, the economy and financial markets are a lot like this movie, except it isn’t that funny and Bill Murray is nowhere to be found.
This is where insurance or guarantees can be a great product when the world goes to hell in a hand basket. How this works in retirement is, these insurance guarantees a life time of pay cheques. Think of it this way, 30 years from now you are well in your 60’s or 70’s and the market decides to drop like a stone, how much time do you have to recover your loses? (You can probably guess the answer). This is where someone could consider exploring an insured annuity a little more. For those of you who are unfamiliar with annuities, you can find a brief description at the end of this post under “Annuities 101”.
A life income annuity (payable until death) is attractive for some investors because the insurance company has to pay it for life, even if you live to 110. However if you die much earlier than you expect, the insurance company keeps all of the money. Rather than gamble with your family’s inheritance, consider purchasing an insured annuity. This is a two-step process where the annuity is backed by a life insurance policy for the same amount. If you die early, the life insurance is paid to your beneficiary tax free.
Here is our first example comparing a GIC versus a life annuity with a matching life insurance policy:
- Current GIC rate 2.7% (five year rate lock-in).
- 65 year-old male purchases $100,000 non-registered annuity and a $100,000 life insurance policy.
- *Tax bracket 31.41% ($40,970 up to $65,345) *Ontario as of 2010 for this example.
After taxes are considered, a GIC of over 6% is needed to equal the annuity. At higher tax brackets, a GIC paying over 7% is needed.
Also, under the annuity strategy, an investor pays less tax since they are showing less taxable income and is less susceptible to OAS claw backs and age amount (age 65) claw back. This could mean many hundreds or thousands of dollars saved every year. Currently interest rates are low, but because the way annuities are taxed, they will always pay a higher income than GIC’s at higher rates.
To lower the insurance premium required to cover the annuity and to get an even higher rate of return, permanent insurance should be considered at a much earlier age (and better health) if cash flow permits.
Let’s consider another example to demonstrate the power of early planning working for you…
An individual who plans well for their future could buy a 20 pay life (paid for 20 years) insurance policy at $2,785 per year (age 40). The insurance coverage would start at $100,000 and would be worth $208,000 by age 65 and have a cash value of $108,000. Not only would this insurance more than cover the annuity purchase at 65, but the individual would have access to the cash value at age 65. At age 85 the death benefit would be $423,000 and the cash value over $325,000.
The main reason to have a second look at permanent insurance is to have less risk, better protection, pay fewer taxes and have more money in retirement!
My Own Advisor: Thanks for reading and I hope you enjoyed this post. Thanks Brian for taking readers inside the world of annunities. I appreciate your willingness to share your expertise!
Got any questions for Brian? Ask away!
Brian Poncelet is an insurance specialist and independent certified financial planner (CFP) working in the financial services industry since 1994. Along with insurance, Brian Poncelet focuses on mortgage and retirement planning.
Want to know more about annuities?
What are they and how can they help?
- An annuity is an insurance product where you pay upfront in exchange for guaranteed payouts until you pass away. Annuities can be a good solution for those who need an income stream in retirement.
A brief history:
- The ancient Romans issued contracts called an “annua” that promised an individual a stream of income for life. Roman citizens would make a one-time payment to the annua, in exchange for lifetime payments made once a year.
- In North America, annuities have been around for over 200 years. The average purchase age appears to be the mid sixties. Annuities are purchased for various reasons but most commonly for peace of mind and tax benefits. Others may look to buy an annuity when they receive a lump sum inheritance.
- Annuity payments consist of both principal and interest. This interest is taxable but is spread over the life of the annuity, therefore the tax is deferred. While your other sources of income (GIC’s, stocks, mutual funds) may eventually be depleted, you cannot outlive your annuity income. Life annuities pay a lifetime of income.
Types of Annuities:
- Term (pretty straight-forward).
- Term Certain Annuities – fixed payment for a fixed period. If annuitant dies during the guarantee period the beneficiaries(s) receive the income payments.
- Life Annuities (as the name suggests, guaranteed regular income for the rest of your life).
- Joint Life Annuities – annuity is purchased on 2 lives, issued with or without a guarantee period. They may be sold as Reducing or Non-Reducing annuities. Upon first death (or death of primary annuitant), the surviving annuitant receives a reduced periodic income. If the Reducing Annuity has a guarantee period, the reduction in periodic income would occur after both events have occurred (the death of one of the annuitants and the expiration of the guarantee period). The terms of the guarantee period are usually based on the age of the youngest annuitant).
- Prescribed Annuities – taxes payable on the income earned are paid evenly throughout the term).
- Non-prescribed Annuities – non-registered only, taxes payable on the income earned are higher in the early years of payments but gradually decrease to zero over time.
- Variable Annuity – with typical annuities, the periodic income paid to an annuitant is predetermined, consisting of principal and interest. The interest was determined at the time of purchase and does not change. With variable annuities the payment can vary because the interest piece is based on the stock market. However most do offer a minimum rate of interest for every year that the annuity remains untouched. In a bear market this does not look so bad. However in a bull market this is expensive. A variable annuity should be bought and thought of as a pension purchased for the long term. Any purchaser seeking immediate income payouts are best to avoid variable annuities.
How is my annuity income determined?
- Current interest rates.
- Male vs. Female – a female annuitant is expected to live longer than a male annuitant of the same age. She will receive a smaller periodic payment because the insurance company assumes that they will have to pay the periodic income for a longer period of life.
- Number of years you want payments guaranteed – the longer the payment period, the smaller the periodic payments.