How annuities can help you fight Groundhog Day
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.
Great work! So with Dividends one pays about 20% less in taxes or nets out at least $100 more than Dividends.
Another point is the dividends is not guaranteed nor is the capital. This is not to say dividends are bad, but safer an in retirement safer and guaranteed and paying less taxes is a compelling reason to prepare for retirement and not close the door with out knowing the facts like some readers may do on other forms of income streams, without knowing all the facts.
ps. Happy New Year.
Happy New Year to you as well Brian.
Looking forward to chatting more in 2012.
Hey, thanks for checking in! I’ve been busy getting myself organized for the holidays.
OK, so if you’re in a 30% tax bracket, making between $41,500 and $66,500 (about 31% MTR), I believe you’re MTR on eligible dividends is about 12%.
So, taking $7,000 per year in dividend income, in 2011, taxed at 12% means you need to fork over about $840 in taxes.
If my math is correct. Again, approximations.
Does that help your analysis Brian?
Any luck with the numbers?
My thoughts are annuities really are a part of lowering your risk, and investing and having low fees is important, but after taxes and inflation how much do we have net in our
The other factor is every dime we pay in taxes is lost opportunity cost.
So say if you paid $100 every year in taxes you did not have to pay and assuming you could get 5% an your money now… compound that every year for 25 years what is it? That is lost opportunity cost. The problem I see is the dividends are buying more (reinvested) and the tax burden gets higher every year…which means more lost money over time.
The end game is how do I spend my money in retirement with less risk and pay less taxes?
I have a calculator to try to address this. Please review this. It is a twist of the annuity idea.
You may want to contact me for details.
@The Dividend Ninja
I don’t know if dividends are producing 7-8% every year, but I am sure on
$7,000 of annuity income you will pay less taxes than the same $7,000 of dividends, Plus I don’t think the income is guaranteed for life.
Mark, can you do the calculations for $7,000 of taxes for dividends assuming one is in a
30 % tax bracket?
I can try and crunch some numbers over the next week, and will post them here. Cheers!
With a RRIF if you choose a life annuity you will never run out money. With a regular RRIF the government forces you take ever higher money out and you are guaranteed to run out of money!
As an example A $100,000 annuity bought at age 71 would pay about $8300 per year for life.
What is the likelyhood of getting 8.3% for life and steady returns without any downturns? Zero.
Plus you will run out of money inyour RRIF (or at least not able to generate $8,300 for life)
Ok, what is the downside? If you die usually after 3 years of this type of annuity your spouse gets Zero. That’s where permanent inurance comes to play, which is cheaper than term insurance…if you plan to live beyond 60 and you deal with this (life insurance) before age 45.
In general, RRSPs just deffer your taxes in the future and should be avoided in most cases for most people. Look at annuities outside an RRSP (because you pay less taxes!!).
Also, like everything else annuities is really about lowering your risk in uncertain times and is important to have some money that is guaranteed and steady …and better than GICs of course.
That’s exactly the math I was looking for….good example: $100,000 annuity bought at age 71 would pay about $8300 per year for life.
Is that today’s rates?
I would say the likelyhood of getting 8.3% for life and steady returns without any downturns today, is close to zero. Unless you are in speculative stocks.
As long as you are in great health, I think this approach might make some great sense for some folks.
Good point, yes, annuities outside an RRSP; less taxes. How much lower are taxes on annuities than your MTR? (Marginal Tax Rate?)
What about RRSP’s being coverted to annuties? How would that scenario work out?
Good question Arshes.
Brian, can you help walk-us through that scenario?
Sorry if I offended you. Let me ask you a few questions if I may.
Did you review the link I offered? http://www.assuris.ca/
Since you brought up insurance, can ask do you own any permanent life insurance?
Do you have dependents?
Yes, I will tie the topics of risk management together, if you are comfortable to answer them.
Brian you obvioulsy have no idea how to entertain disccussion on a blog, or accept that someone may have a different view than you. Instead you have resorted to going on a personal attack. That is not how you teach people or entertain discussion – far from it. Whether I am write or wrong is irrelevant.
At the end of the day you are independent insurance broker. It is in your interest to sell annuities, insurance, and probably actively-managed mutual funds to people. Your livelihood depends on it, and that is OK – I respect that. There are people who need your services, and I amsure you always put your client’s interests at heart.
“The Dividend Ninja’s comments seem to suggest to me he really does not understand risk management, taxes and what guarantees one gets with insurance. I am sure he is a nice guy, but is too fixed on dividends without looking at other ideas…”
This remark makes no sense to me, and is completely innapropriate, since you actually have no idea about my pension plan at work, my insurance, my taxes, nor my investments. I don’t think it is appropraite for you to make personal comments or grandeous assumptions about me in this manner – and I suggest you refrain from doing so further.
Hi Dividend Ninja!
Did you get a chance to visit http://www.assuris.ca/
This answers your comment “I am very wary to invest in financial companies such as ManuLife or SunLife, yet alone buy their products. ManuLife is in big financial trouble right now. I would be very wary to take tens of thousands of dollars invest into a ManuLife annuity for example and watch the issuing company go under – there is always that possibility.”
Which of course is missplaced.
I know your quick to comment which great, but I hope you are open minded to do a bit of homework.
I hope I am wrong and you will come back to comment.
Great Question Mark,
If something is on sale should you buy it?
You know the answer! Right now all insurance companies are increasing premiums for permanent life coverage (because of the low interst rates). If you believe like I do rates will be low for years then getting coverage (permanent makes sense) this gives you options later in life…plus it is called risk management. If rates go higher the annuity payments will always pay higher than GIC by a wide margin.
As far as annuities go for conservative investors (usually the ones with at least $250,000 plus)
They love annuities…compared to GICs so sales are good! Some who have done planning (having insurance while they are young) can wait. So they can get a annuity at today’s rate, or wait. As they get older say above 70 the annuities pay ever higher rates (even with low interest rates).
Mark, you may want to check out http://www.assuris.ca/
The Dividend Ninja’s comments seem to suggest to me he really does not understand risk management, taxes and what guarantees one gets with insurance. I am sure he is a nice guy, but is too fixed on dividends without looking at other ideas.
Remember annuities like everything else helps lower your risk at retirement, and lower your taxes, and is guaranteed. Should you put all your eggs there, NO!
The $800,000 example vs. $1,000,000 ( if you want me to do it) using insurance means you can have less money inretirement, yet spend or live better than someone who has 20% more $$$, assuming they use insurance as the right tool for retirement.
Assuming most people agree that the ability to spend and enjoy money in retirement is more important than to try and save and hope the market gives us a healthy rate of return and assuming readers (like Ninja have an open mind about taxes) I can suggest some ideas on how to say have $800,000 non-registered money (with a low rate of return of say 4%) one can enjoy and spend better than if one had $1,000,000 non-registered (and a higher rate of return say 5% in retirement …at 65.
The person with $800,000 can spend more money pay less taxes and have better protection for their family, (using insurance of course!) than a person who has $1,000,000 (and no insurance) at retirement. Assuming open monies. Let me know if this sounds interesting.
Your scenario is definitely an interesting one and it goes to show how a variety of products, including annuities, might help some Canadians provide the gurananteed income they are looking for long after their working years are over. I know for me, I’m working on creating a basket of dividend-paying stocks that will complement my registered, indexed savings. Add in my DB pension at work, and hopefully in another 20 years (I’ll have 30 years of service by then), I should be ready to retire without any worries. That DB pension wil be worth well-over a million dollars in future value. Annuities may or may not fit into my equation, depending upon my health, income needs and other products in my portfolio.
For folks that managed to save $800,000 non-registered money, but have no pension, an annuity might just be the thing they need as part of their retirement plan.
I wanted to ask you, what’s your take on this low interest environment and how this environment has affected lifeco’s and their ability to payout guaranteed income products? Are people shying away from annunities based on this environment? What are you seeing?
Mark – My Own Advisor
Hi Dividend Ninja,
I understand your point of view but if what you believed was true was not when would you like to know?
Lets look at guarantees. My suggestion is to visit http://www.assuris.ca/
For annuities you are protected 100% for the first $2,000 per month. So if you have say $300,000 of annuitie you are covered for life. Above this amount it is 85% of any monthly payout.
Every life insurance company authorized to sell insurance policies in Canada is
required, by the federal, provincial and territorial regulators, to become a member
Ninja…please spend some time on the site and let me know your thoughts.
The next is taxes. Assuming taxes will be with us until we die the annuites have advantages that
dividends don’t have…guarantees and less taxes.
That is not to say your stocks or dividends is bad just different. Assuming your parents (say in there 60’s would rather have guaranteed income or capital that goes up and down and pay more taxes.
Brian Nice post!
I am not a fan of annuities, and I probably never will be. Here’s my thoughts:
(1) Most annuities are sold by insurance companies such as ManuLife as an example, they are also sold by “financial advisors” aka mutual fund and insurance sales people. Your best interests are not always at heart, even if you buy through the banks. I liken buying an annuity to buying a car from a car salesman. These are complex products where the cards are stacked against you before you buy.
(2) I am very wary to invest in financial companies such as ManuLife or SunLife, yet alone buy their products. ManuLife is in big financial trouble right now. I would be very wary to take tens of thousands of dollars invest into a ManuLife annuity for example and watch the issuing company go under – there is always that possibility.
(3) Annuities are like GICS or Bonds, there is a right and wrong time to buy them. In this low interest rate climate, this is the worst time to buy annuities. In the past they have been great portfolio income generators – but not anymore.
Jon Evan yes a dividend portfolio would outperfrom an annuity in this current market climate, but it hasn’t always been that way. Also the value of a stock portfolio will fluctuate over time, but an annuity is constant.
The Dividend Ninja
I would think a dividend portfolio would outperform and be cheaper than an annuity.
Here is a story that might help your readers…
Lets say you have 4 golfers, they put in $100 each (they are 65 years old) they split the money when they meet up next year.
Next year only 3 three golfers show up.
They split the money $400/3
A 33% rate of return
This is called a mortality credit.
There is no other way to get a guaranteed high rate of return even with low interest rates. Living has its benefits!
What is one of the biggest fears people face when it comes to their retirement savings?
Answer: Outliving their money Longevity Risk!
Absolutely living has its benefits! Life annuities can definitely lessen the stress some folks fear, outliving their money.
@ Think Dividends
The GIC pays $2700 (based on the $100,000) per year
less taxes $848.07
Net is $1,851.93
If you want a high payout go life annunity. I think what you mean is to have a guarantee payout for ten years…right? If so, the pay out is less.
You are right the annuities are considered a blend of income and return of capital, but the annuities offer a guarantee plus based on mortality credit. So the older one is the higher the payout. In fact the payout at older ages could be 10% per year guaranteed.
It might be less confusing to buy a Life Annuity Guaranteed for 10 years; this would usually return the initial amount paid for the annuity.
Taxes are lower on Annuities as the payments made are considered a blend of income and return of capital.
Good points and correct in the blend of income and ROC, although I’m sure Brian will respond as well.
Have you ever considered one?
I think these products make sense for those without some guaranteed income, i.e., no pension. I’m not saying you need to be all-in with life annuities, rather it’s a consideration that shouldn’t be dismissed entirely.
Thanks for checking in Susan!
The math in the table is incorrect. For the GIC: $2,700 less $848.07 does not equal $2,237.63.
Thanks for the keen eye, very much appreciated!