A question frequently asked by clients who face imminent retirement is: “Will my money last?” A proper response from a financial advisor requires examining several issues that could affect the client and determining whether guaranteed products can fit into his or her portfolio.
With interest rates at historically low levels and financial markets volatile, many clients want some sort of guarantee to cover their day-to-day living expenses at least. But whether your clients should buy an annuity and for how much depends on what other kinds of guaranteed income clients already have, their age and their risk tolerance.
Many Canadians have part of their retirement income guaranteed. Clients eligible for both Canada Pension Plan (CPP) and old-age security benefits can expect to receive up to about $20,000 a year, adjusted for inflation, says Clay Gillespie, financial advisor, portfolio manager and managing director with Rogers Group Financial Advisors Ltd. in Vancouver.
But clients who retire before they qualify for these benefits or who wish to defer collecting CPP may want some guaranteed bridge income. That can be provided by a term annuity, says Stuart Small, retirement income specialist and partner with Continuum II Inc. in Burlington, Ont. Many products provide regular payments in retirement, he says, ranging from fixed or variable annuities to guaranteed minimum withdrawal benefit (GMWB) products.
With a life annuity, for example, your client will never outlive his or her investment. That is a major advantage, Gillespie says, as life expectancies rise.
“If [the client] lives a long life,” Gillespie says, “the sum of all payments will far exceed the capital spent to purchase the annuity.”
On the other hand, if the client dies prematurely, the amount of payments received may be significantly less than the capital used to buy the annuity.
Clients who have a defined-contribution pension plan can take that money upon retirement and buy a life annuity. “They have guaranteed their income for life and never have to worry about it,” Gillespie says. “And that’s very appealing to people.”
Another risk your clients must consider when dealing with retirement income involves inflation. Although inflation is low now, if it averages 2% per year, prices will double approximately every 33 years, Small says. This can prove costly if clients leave full-time work and have a long life expectancy. “Guaranteed income products [with an inflation-indexing option] can assist with that type of risk,” he says.
Clients have the option of adding a guarantee period to the annuity, says Gillespie. For example, a joint life annuity with a 10-year guarantee means the income will last for the lifetime of the spouse who lives longest or 10 years. So, there will be at least 10 years’ worth of payments under any circumstances. For example, if both spouses die after three years, there will be seven years of payments to the estate.
Although many features can be added to an annuity, the more features that are added, the lower the monthly income.
The main disadvantage of an annuity, Gillespie says, is that clients lose control of their capital and they could be locking in at historically low interest rates. Annuity payments are based on interest rates and the age of the client. “When you do the math,” he says, “annuities start to get really attractive for people coming out of registered plans around age 75.”
Gillespie frequently recommends that clients with only registered money put half their funds in a life annuity and leave the rest in their RRIF, especially when those clients reach age 75. They then can structure their lifestyles as they see fit with the RRIF. Most retirees spend more money in their first 10 years of retirement than in the next 10 years.
GMWB products combine investments and insurance. Clients receive a guaranteed minimum income every year, with the potential for investment gains to help increase income over time. However, management fees for these products can be higher than for other types of investment funds.
© 2016 Investment Executive. All rights reserved.