The life annuity is a retirement investing product with to-die-for optics.
Life annuities pay a regular, guaranteed amount of money every month for as long as you live, which addresses two big retirement risks. One, that the stock market will crash just as you’re about to start drawing down on your retirement savings and, two, that you’ll outlive your savings.
Worry-free income for people who don’t have company pension plans – that’s the idealized view of life annuities. But for reasons that relate both to current financial market conditions and the way in which life annuities are constructed, their real-world appeal is limited.
The term annuity is a broad one that encompasses segregated funds, a type of mutual fund with insurance guarantees, as well as the guaranteed minimum withdrawal benefit (GMWB), which is a retirement income product that protects you from losses in the markets while offering the possibility of investment gains.
Life annuities come with a few different variations, but the basic concept is that you turn over a lump sum to an insurance company that commits to paying you a fixed amount for the rest of your life.
Long-term interest rates have a big impact on the amount of your monthly payments, but there’s another factor as well, called mortality credits. Think of mortality credits as premiums paid by annuity holders who died sooner than expected. These premiums help increase the amount of the monthly payments you’ll get when you buy an annuity.
Lowell Aronoff, an annuity expert and chief executive officer of Cannex Financial Exchanges, says life annuities are an answer for people who are worried about how they will cover the basic costs of living in retirement.
“You need to lock in a certain amount of assets to cover these costs for the rest of your life, and annuities do that more efficiently than anything else,” Mr. Aronoff said.
Life annuity sales have risen in recent years, but not as much as you might expect, given the level of financial market uncertainty we’ve seen. The Canadian Life and Health Insurance Association reports that assets in life annuities totalled $25.9-billion as of last Sept. 30, up almost 6 per cent from the end of 2009 (that’s premiums paid plus investment gains on that money, minus money paid out to annuitants).
Asher Tward, vice-president of estate planning at Tri-Delta Financial, has a theory that life annuities aren’t more popular because the rules are so rigid. Once you buy an annuity, you can’t cash it in or get your money back.
“People want to do the conservative thing, but they don’t want to lock in,” Mr. Tward said. “People hating locking themselves into something for a long time.”
The locked-in aspect is a particular worry now, with concern about inflation mounting. A life annuity cannot protect you against higher living costs unless you pay extra for one that offers inflation-indexed payments.
There are also a couple of structural reasons that make life annuities unattractive, one of them being the fact that they’re a strikingly bad value if you buy one and die soon after. If you don’t ante up the extra money for an annuity that keeps money flowing to a spouse or your estate upon your death, your annuity investment passes to other investors through those mortality credits.
Another negative is that annuities can seem opaque when you try to compare them with other investing options. The mix of factors insurers consider in determining annuity payouts include the amount of money you contribute, your age, long-term government bond rates, mortality credits and fees to pay advisers who sell annuities. It’s very difficult to compute the monthly payments of an annuity into an annualized rate of return based on a scenario where you, say, buy at 65 and live to 85 or 90.
Today’s very low interest rates add to the uncertainty about the long-term attractiveness of an investment in an annuity. “If we were in a high-rate environment, it would be a fairly easy decision to buy one,” Mr. Tward said.
Annuity payments vary from company to company, so shopping around is mandatory. A survey on Cannex’s database this week found that a 65-year-old male buying a plain $100,000 life annuity this week for a registered retirement savings plan would be able to generate monthly income ranging from $579 to $652, while a female of the same age would have had a range of $556 to $579.
Consider not just the amount of a life annuity payout, but also the insurer’s financial stability rating from a company such as A.M. Best (ambest.com). Note that the life insurance industry’s consumer protection plan, Assuris, covers the higher of $2,000 per month or 85 per cent of your monthly payment if your insurer becomes insolvent.
When considering an annuity, remember that the Canada Pension Plan and Old Age Security provide income for life, as does a company pension.
Life Annuities: The ABCs
Where to buy them
Where to put them
When to buy one
How to use them
|Type of annuity||What it’s designed to do||Hypothetical monthly annuity income
|Provide you with income for life.||$650|
|Life plus five-year guarantee
|Provide you with income for life. Guarantees 60 payments to your estate in case you die within the first five years of your contract.
|Life plus 10-year guarantee||Provide you with income for life. Guarantees 120 payments to your estate in case you die within the first 10 years of your contract.
|Life plus joint-and-last-survivor||Provide income for life for you and your spouse. Payments stop when both of you have died.
|Indexed life annuity||Provide income for life. Payments increase with inflation to maintain your buying power.||$400 to start (goes up when prices rise)|
To learn more about Life Annuities or your options at Retirement, please contact The Leslie Group Limited at (416)510-8966. The Leslie Group is a full service employee benefits consulting firm that is committed to providing you with the best advice needed to manage your group retirement plan.
This article was taken and edited for content from the February 26th, 2011 Globe & Mail.